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Fiscal Planning in an Era of Economic Stability

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Author Info
Doug Hostland

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Abstract

Recent research has shown that the volatility of output growth and inflation has declined over time in Canada, and most other industrialized countries. This paper examines the implications for medium-term fiscal planning at the federal level in Canada. We examine the performance of mean forecasts of output growth and inflation obtained from surveys of private sector forecasters in Canada and the US. The results indicate a substantial decline in forecast uncertainty since the mid-1980s. We then calibrate a stochastic simulation model to match the performance of private sector forecasts over the historical period. Stochastic simulation experiments are used to illustrate how varying the amount of uncertainty surrounding economic forecasts influences debt reduction outcomes. The reduction in forecast uncertainty observed over the historical period is found to have a major impact on the dispersion of debt reduction outcomes when the fiscal planning framework involves multi-period commitments to tax and spending measures. The simulation results also demonstrate that keeping inflation stable and avoiding over-optimistic estimates of potential output growth help ensure that the debt-to-GDP ratio is kept on a clear, downward profile in the presence of uncertainty surrounding economic developments.

Des recherches récentes ont révélé une réduction progressive de la volatilité de la croissance de la production et de l’inflation au Canada et dans la plupart des pays industrialisés. Dans le présent document, nous étudions les répercussions de ce phénomène sur la planification budgétaire à moyen terme dans l’administration fédérale au Canada. Dans un premier temps, nous examinons la performance des prévisions moyennes liées à la croissance de la production et à l’inflation établies par des prévisionnistes du secteur privé au Canada et aux États-Unis. Les résultats démontrent une réduction marquée de l’incertitude dans les prévisions depuis le milieu des années 80. Dans un deuxième temps, nous calibrons un modèle de simulation stochastique afin de reproduire la performance des prévisions dans le secteur privé au cours de la période historique. Les expériences de simulation stochastique permettent d’illustrer l’influence de l’incertitude entourant les prévisions économiques sur la réduction de la dette. Nous avons constaté que la réduction de l’incertitude dans les prévisions observée au cours de la période historique a une incidence majeure sur la dispersion de la réduction de la dette lorsque le cadre de planification budgétaire comprend des engagements sur plusieurs périodes à l’égard de mesures touchant les recettes ou les dépenses. De plus, les résultats de la simulation indiquent qu’en stabilisant l’inflation et en établissant des prévisions prudentes au chapitre de la croissance de la production, on peut faire en sorte que le ratio de la dette au PIB se maintienne fermement sur une pente descendante face à l’incertitude entourant les développements économiques.

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Paper provided by Department of Finance Canada in its series Working Papers-Department of Finance Canada with number 2003-10.

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