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A Solution to Fiscal Procyclicality: the Structural Budget Institutions Pioneered by Chile

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  • Jeffrey Frankel

Abstract

Historically, many countries have suffered a pattern of procyclical fiscal policy: spending too much in booms and then forced to cut back in recessions, thereby exacerbating the business cycle. This problem has especially plagued Latin American commodity-producers. Since 2000, fiscal policy in Chile has been governed by a structural budget rule that has succeeded in implementing countercyclical fiscal policy. The key innovation is that the two most important estimates of the structural versus cyclical components of the budget – trend output and the 10-year price of copper – are made by expert panels and thus insulated from the political process. Chile’s fiscal institutions could usefully be emulated everywhere, but especially in other commodityexporting countries. This paper finds statistical support for a series of hypotheses regarding forecasts by official agencies that have responsibility for formulating the budget. 1) Official forecasts of budgets and GDP in a sample of 33 countries are overly optimistic on average. 2) The bias toward over-optimism is stronger the longer the horizon 3) The bias is greater among European governments that are politically subject to the budget rules in the Stability and Growth Pact. 4) The bias is greater at the extremes of the business cycle, particularly in booms. 5) In most countries, the real growth rate is the key macroeconomic input for budget forecasting. In Chile it is the price of copper. 6) Real copper prices mean-revert in the long run, but this is not always readily perceived. 7) Chile’s official forecasts are not overly optimistic on average. 8) Chile has apparently avoided the problem of official forecasts that unrealistically extrapolate in boom times. The conclusion is that official forecasts, if not insulated from politics, tend to be overly optimistic and that the problem can be worse when the government is formally subject to a budget rule. The key innovation that has allowed Chile in general to achieve countercyclical fiscal policy, and in particular to run surpluses in booms, is not just a structural budget rule in itself, but rather the regime that entrusts to panels of independent experts the responsibility for estimating the extent to which contemporaneous copper prices and GDP have departed from their long-run averages.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 604.

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Date of creation: Jan 2011
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Handle: RePEc:chb:bcchwp:604

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Fiscal Policy in Developing Countries: Escape from Procyclicality
    by Mark Thoma in Economist's View on 2011-06-24 07:24:00
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  1. Roel Beetsma & Benjamin Bluhm & Massimo Giuliodori & Peter Wierts, 2011. "From First-Release to Ex-Post Fiscal Data: Exploring the Sources of Revision Errors in the EU," Tinbergen Institute Discussion Papers 11-080/2, Tinbergen Institute.
  2. Carlos A. Vegh & Guillermo Vuletin, 2012. "Overcoming the Fear of Free Falling: Monetary Policy Graduation in Emerging Markets," NBER Working Papers 18175, National Bureau of Economic Research, Inc.
  3. Roel Beetsma & Benjamin Bluhm & Massimo Giuliodori & Peter Wierts, 2011. "From First-Release to Ex-Post Fiscal Data: Exploring the Sources of Revision Errors in the EU," Tinbergen Institute Discussion Papers 11-080/2, Tinbergen Institute.
  4. Annabelle Mourougane, 2011. "Refining Macroeconomic Policies to Sustain Growth in Brazil," OECD Economics Department Working Papers 899, OECD Publishing.
  5. Cordella, Tito & Federico, Pablo & Vegh, Carlos & Vuletin, Guillermo, 2014. "Reserve requirements in the brave new macroprudential world," Policy Research Working Paper Series 6793, The World Bank.
  6. Sorrentino, Angelica & Thomasz, Esteban Otto, 2014. "Incidencia del Complejo Sojero: Implicancias en el Riesgo Macroeconómico
    [Macroeconomic Risk: The incidence of soy exports in Argentina between 2003 and 2012]
    ," MPRA Paper 55767, University Library of Munich, Germany.
  7. Georgia Kaplanoglou & Vassilis T. Rapanos, 2013. "Fiscal Deficits and the Role of Fiscal Governance: The case of Greece," Economic Analysis and Policy (EAP), Queensland University of Technology (QUT), School of Economics and Finance, vol. 43(1), pages 5-30, March.

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