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Fiscal stabilisation in real time: An exercise in risk management

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  • Larch, Martin
  • Kumps, Diederik
  • Cugnasca, Alessandro

Abstract

Fiscal policy in the EU has been largely pro-cyclical. We propose an approach that supports more informed decision making aimed at stabilising output. Rather than relying on notoriously uncertain point estimates of the cycle, our approach is built around the management of risks: (i) launching discretionary measures to support or dampen aggregate demand when, in hindsight, no measures would have been required, versus (ii) remaining inactive when, in hindsight, a stabilisation measure would have been warranted. A rational policymaker can manage these risks by using information on past forecast errors and take stabilisation measures only when real-time estimates of the cycle exceed an optimal threshold. We show that the observed tendency to run pro-cyclical fiscal policies can reflect two complementary factors: a preference for activism combined with the desire to avert downside risks to growth, while putting a blind eye on upside risks.

Suggested Citation

  • Larch, Martin & Kumps, Diederik & Cugnasca, Alessandro, 2021. "Fiscal stabilisation in real time: An exercise in risk management," Economic Modelling, Elsevier, vol. 99(C).
    • Handle: RePEc:eee:ecmode:v:99:y:2021:i:c:s0264999321000778
    DOI: 10.1016/j.econmod.2021.03.013
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    Cited by:

    1. Katja Schmidt & Antoine Sigwalt, 2022. "Fiscal policy orientation in the euro area in real-time," Working papers 896, Banque de France.
    2. Cronin, David & McInerney, Niall, 2023. "Official fiscal forecasts in EU member states under the European Semester and Fiscal Compact – An empirical assessment," European Journal of Political Economy, Elsevier, vol. 76(C).
    3. Larch, Martin & Claeys, Peter & Van Der Wielen, Wouter, 2022. "The scarring effects of major economic downturns: The role of fiscal policy and government investment," EIB Working Papers 2022/14, European Investment Bank (EIB).

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    More about this item

    Keywords

    Fiscal stabilisation; Signalling approach; Pro-cyclical fiscal policy; Risk management; Real-time output gap estimates;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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