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

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  • Jeffrey A. 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. This problem has especially plagued Latin American commodity exporters. Since 2000, fiscal policy in Chile has been governed by a structural budget rule that has succeeded in implementing countercyclical fiscal policy. Official estimates of trend output and the 10-year price of copper – which are key to the decomposition of the budget into structural versus cyclical components – are made by expert panels and thus insulated from the political process. Chile’s fiscal institutions hold useful lessons everywhere, but especially in other commodity exporting 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 33-country sample are overly optimistic on average. 2) The bias is stronger at longer horizons 3) The bias is greater among European governments that are politically subject to the budget rules in the Stability and Growth Pact (SGP). 4) The bias is greater 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 readily perceived. 7) Chile has avoided the problem of overly optimistic official forecasts. The conclusion: official forecasts tend to be overly optimistic, if not insulated from politics, and the problem can be worse when the government is formally subject to budget rules. The key innovation that has allowed Chile to achieve countercyclical fiscal policy in general, and to run surpluses in booms in particular, is not just a structural budget rule in itself, but a regime that entrusts to independent expert panels responsibility for estimating long-run trends in copper prices and GDP.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16945.

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Date of creation: Apr 2011
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Publication status: published as Jeffrey Frankel, 2011. "A Solution to Fiscal Procyclicality: the Structural Budget Institutions Pioneered by Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 14(2), pages 39-78, August.
Handle: RePEc:nbr:nberwo:16945

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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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  4. 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.
  5. 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.
  6. 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.
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