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Over-optimistic official forecasts and fiscal rules in the eurozone

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  • Jeffrey Frankel
  • Jesse Schreger

Abstract

Eurozone members are supposedly constrained by the fiscal caps of the Stability and Growth Pact. Yet ever since the birth of the euro, members have postponed painful adjustment. Wishful thinking has played an important role in this failure. We find that governments’ forecasts are biased in the optimistic direction, especially during booms. Eurozone governments are especially over-optimistic when the budget deficit is over the 3 % of GDP ceiling at the time the forecasts are made. Those exceeding this cap systematically but falsely forecast a rapid future improvement. 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 biased forecasts can defeat budget rules. What is the record in Europe with national rules? The bias is less among eurozone countries that have adopted certain rules at the national level, particularly creating an independent fiscal institution that provides independent forecasts.
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  • Jeffrey Frankel & Jesse Schreger, "undated". "Over-optimistic official forecasts and fiscal rules in the eurozone," Working Paper 83126, Harvard University OpenScholar.
  • Handle: RePEc:qsh:wpaper:83126
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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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