Over-Optimistic Official Forecasts in the Eurozone and Fiscal Rules
AbstractWhy do countries find it so hard to get their budget deficits under control? Systematic patterns in the errors that official budget agencies make in their forecasts may play an important role. Although many observers have suggested that fiscal discipline can be restored via fiscal rules such as a legal cap on the budget deficit, forecasting bias can defeat such rules. The members of the eurozone are supposedly constrained by the fiscal caps of the Stability and Growth Pact. Yet ever since the birth of the euro in 1999, members have postponed painful adjustment by making overly optimistic forecasts of future growth and budget positions and arguing that the deficits will fall below the cap within a year or two. The new fiscal compact among the euro countries is supposed to make budget rules more binding by putting them into laws and constitutions at the national level. But what is the record with such national rules? Our econometric findings are summarized as follows: -Governments' budget forecasts are biased in the optimistic direction, especially among the Eurozone countries, especially when they have large contemporaneous budget deficits, and especially during booms. -Governments' real GDP forecasts are similarly over-optimistic during booms. -Despite the well-known tendency of eurozone members to exceed the 3% cap on budget deficits, often in consecutive years, they almost never forecast that they will violate the cap in the coming years. This is the source of the extra bias among eurozone forecasts. If euro area governments are not in violation of the 3% cap at the time forecasts are made, forecasts are no more biased than other countries. -Although euro members without national budget balance rules have a larger over-optimism bias than non-member countries, national fiscal rules help counteract the wishful thinking that seems to come with euro membership. The reason is that when governments are in violation of the 3% cap the national rules apparently constrain them from making such unrealistic forecasts. -Similarly, the existence of an independent fiscal institution producing budget forecasts at the national level reduces the over-optimism bias of forecasts made when the countries are in violation of the 3% cap.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number rwp12-041.
Date of creation: Sep 2012
Date of revision:
Contact details of provider:
Postal: 79 JFK Street, Cambridge, MA 02138
Web page: http://www.ksg.harvard.edu/research/working_papers/index.htm
More information through EDIRC
Other versions of this item:
- Jeffrey A. Frankel & Jesse Schreger, 2012. "Over-optimistic Official Forecasts in the Eurozone and Fiscal Rules," NBER Working Papers 18283, National Bureau of Economic Research, Inc.
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-30 (All new papers)
- NEP-EEC-2012-09-30 (European Economics)
- NEP-FOR-2012-09-30 (Forecasting)
- NEP-MAC-2012-09-30 (Macroeconomics)
- NEP-PBE-2012-09-30 (Public Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Douglas Sutherland & Robert W.R. Price & Isabelle Joumard, 2005. "Fiscal Rules for Sub-central Governments: Design and Impact," OECD Economics Department Working Papers 465, OECD Publishing.
- Forni, Lorenzo & Momigliano, Sandro, 2004.
"Cyclical sensitivity of fiscal policies based on real-time data,"
4315, University Library of Munich, Germany.
- Lorenzo Forni & Sandro Momigliano, 2004. "Cyclical sensitivity of fiscal policies based on real-time data," Temi di discussione (Economic working papers) 540, Bank of Italy, Economic Research and International Relations Area.
- Carlos Marinheiro, 2007.
"The Stability and Growth Pact, Fiscal Policy Institutions, and Stabilization in Europe,"
GEMF Working Papers
2007-07, GEMF - Faculdade de Economia, Universidade de Coimbra.
- Carlos Marinheiro, 2008. "The stability and growth pact, fiscal policy institutions and stabilization in Europe," International Economics and Economic Policy, Springer, vol. 5(1), pages 189-207, July.
- Xavier Debrun & Laurent Moulin & Alessandro Turrini & Joaquim Ayuso-i-Casals & Manmohan S. Kumar, 2008. "Tied to the mast? National fiscal rules in the European Union," Economic Policy, CEPR & CES & MSH, vol. 23, pages 297-362, 04.
- Roel Beetsma & Massimo Giuliodori & Peter Wierts, 2009. "Planning to cheat: EU fiscal policy in real time," Economic Policy, CEPR & CES & MSH, vol. 24, pages 753-804, October.
- Charles Wyplosz, 2005. "Fiscal Policy: Institutions versus Rules," National Institute Economic Review, National Institute of Economic and Social Research, vol. 191(1), pages 64-78, January.
- 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.
- Frankel, Jeffrey A., 2011. "Over-optimism in Forecasts by Official Budget Agencies and its Implications," Scholarly Articles 8705906, Harvard Kennedy School of Government.
- Nina Budina & Andrea Schaechter & Anke Weber & Tidiane Kinda, 2012. "Fiscal Rules in Response to the Crisis," IMF Working Papers 12/187, International Monetary Fund.
- Lars Jonung & Martin Larch, 2004.
"Improving fiscal policy in the EU: the case for independent forecasts,"
European Economy - Economic Papers
210, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
- Lars Jonung & Martin Larch, 2006. "Improving fiscal policy in the EU: the case for independent forecasts," Economic Policy, CEPR & CES & MSH, vol. 21(47), pages 491-534, 07.
- Milesi-Ferretti, Gian Maria, 2001.
"Good, Bad or Ugly? On the Effects of Fiscal Rules with Creative Accounting,"
CEPR Discussion Papers
2663, C.E.P.R. Discussion Papers.
- Milesi-Ferretti, Gian Maria, 2004. "Good, bad or ugly? On the effects of fiscal rules with creative accounting," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 377-394, January.
- Gian-Maria Milesi-Ferretti, 2000. "Good, Bad or Ugly?on the Effects of Fiscal Rules with Creative Accounting," IMF Working Papers 00/172, International Monetary Fund.
- Alberto Alesina & Ricardo Hausmann & Rudolf Hommes & Ernesto Stein, 1996.
"Budget Institutions and Fiscal Performance in Latin America,"
NBER Working Papers
5586, National Bureau of Economic Research, Inc.
- Alesina, Alberto & Hausmann, Ricardo & Hommes, Rudolf & Stein, Ernesto, 1999. "Budget institutions and fiscal performance in Latin America," Journal of Development Economics, Elsevier, vol. 59(2), pages 253-273, August.
- Ricardo Hausmann & Alberto Alesina & Rudolf Hommes & Ernesto H. Stein, 1998. "Budget Institutions and Fiscal Performance in Latin America," Research Department Publications 4160, Inter-American Development Bank, Research Department.
- Stein, Ernesto & Hommes, Rudolf & Hausmann, Ricardo & Alesina, Alberto, 1999. "Budget Institutions and Fiscal Performance in Latin America," Scholarly Articles 4553021, Harvard University Department of Economics.
- 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.
- Beetsma, Roel & Bluhm, Benjamin & Giuliodori, Massimo & Wierts, Peter, 2011. "From First-Release to Ex-Post Fiscal Data: Exploring the Sources of Revision Errors in the EU," CEPR Discussion Papers 8413, C.E.P.R. Discussion Papers.
- Ashiya, Masahiro, 2007. "Forecast accuracy of the Japanese government: Its year-ahead GDP forecast is too optimistic," Japan and the World Economy, Elsevier, vol. 19(1), pages 68-85, January.
- Stephan, Andreas & Brück, Tilman, 2005.
"Do Eurozone Countries Cheat with their Budget Deficit Forecasts?,"
Working Paper Series
2005,5, European University Viadrina Frankfurt (Oder), The Postgraduate Research Programme Capital Markets and Finance in the Enlarged Europe.
- Tilman Brück & Andreas Stephan, 2006. "Do Eurozone Countries Cheat with their Budget Deficit Forecasts?," Kyklos, Wiley Blackwell, vol. 59(1), pages 3-15, 02.
- Tilman Brück & Andreas Stephan, 2005. "Do Eurozone Countries Cheat with Their Budget Deficit Forecasts?," Discussion Papers of DIW Berlin 508, DIW Berlin, German Institute for Economic Research.
- Martin MÃ¼hleisen & KornÃ©lia KrajnyÃ¡k & Stephan Danninger & David Hauner & Bennett Sutton, 2005. "How Do Canadian Budget Forecasts Compare with Those of Other Industrial Countries?," IMF Working Papers 05/66, International Monetary Fund.
- George Kopits, 2001. "Fiscal Rules," IMF Working Papers 01/145, International Monetary Fund.
- 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.
- Jeffrey Frankel, 2011.
"Over-optimism in forecasts by official budget agencies and its implications,"
Oxford Review of Economic Policy,
Oxford University Press, vol. 27(4), pages 536-562.
- Jeffrey A. Frankel, 2011. "Over-optimism in Forecasts by Official Budget Agencies and Its Implications," NBER Working Papers 17239, National Bureau of Economic Research, Inc.
- Masahiro Ashiya, 2005. "Twenty-two years of Japanese institutional forecasts," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 1(2), pages 79-84, March.
- Jung, Alexander & El-Shagi, Makram & Giesen, Sebastian, 2013.
"Does Central Bank Staff Beat Private Forecasters?,"
Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order
79925, Verein für Socialpolitik / German Economic Association.
- Frankel, Jeffrey, 2013. "The Future of the Currency Union," Working Paper Series rwp13-015, Harvard University, John F. Kennedy School of Government.
- Paloviita, Maritta, 2012. "Fiscal planning and implementation: euro area analysis based on real time data," Research Discussion Papers 34/2012, Bank of Finland.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.