Cyclical budget balance measurement

Government balances are often adjusted for changes in economic activity in order to draw a clearer picture of the underlying fiscal situation and to use this as a guide to fiscal policy analysis. International organisations estimate the cyclical component of economic activity by the current level of the output gap. Using elasticities of tax and public expenditures to GDP, they compute the cyclical part of budget balance. The structural budget balance is defined as the remainder. Our approach is different, as it rests on the estimation of a bivariate VAR. Variables used are the budget balance in percents of GDP, and the annual rate of growth of GDP. The structural part of the budget balance is defined as the one which would have occurred had GDP never deviated from its trend. Hence, past business cycles affect the cyclical part of the budget balance, contrary to what more traditional methods assume. In our method, systematic cyclical policies de facto affect the cyclical balance. Our estimated changes in structural balances are consistent with previous methods, given the fairly large standard errors. However, these methods yield significantly different predictions at the peaks and troughs of business cycles : according to our method, structural balances consolidated by more in 1990-1991 and deteriorated by more in 1994-1995.