Successfully reported this slideshow.

Macroeconomic Forecasting and the Sustainability of Public Finances

320 views

Published on

In order to asses the current and future fiscal stance, an independent assessment
of forecasts is needed to avoid the deficit bias of government forecasts
Forecasts of macroeconomic and fiscal variables, but also with an assessment of
potential macroeconomic imbalances, and their effects on the budget balance
Also needed a methodology to compute structural components of public
accounts (cyclical position and elasticities)
Many forecasting and measurement problems: some are well-known, others are
less well-known (real time analysis, asset prices and bubbles, changes in demand
and sectorial composition, etc.)
Fiscal policy in practice is as much art as science … but science is quite useful!
(as Blinder, 1997, on the dark art of monetary policy)

Published in: Economy & Finance, Business
  • Be the first to comment

Macroeconomic Forecasting and the Sustainability of Public Finances

  1. 1. Macroeconomic Forecasting and theSustainability of Public FinancesRafael DoménechAn Independent Fiscal Responsibility Authority For SpainIEF, Madrid, May 13-14, 2013
  2. 2. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 2Objectives of an independent fiscal authorityMany academic contributions, starting in the mid-1990s (e.g., Calmfors andWren-Lewis, 2011, Debrun et al., 2009, and others), have proposedindependent fiscal authorities to prevent the deficit bias of fiscal policy(2) Proposal of a methodology for the estimation of trend forecasts ofpublic revenues and expenditures(1) Assessment of economic forecasts, budget stability along the businesscycle and the sustainability of public debt(3) Evaluation of the Stability Programme (including the pension system),assessment of regional governments’ budgets and financial rebalancingplans
  3. 3. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 3Why now?(1) Despite previous stability laws, evidence of persistent structural deficitsand the current situation of public accounts, with debt on an unsustainablepath that should be curbed(3) Demographic challenges with significant implications upon thesustainability of public accounts, particularly for the pension system(2) A Constitutional reform in 2011 and an new Budget Stability Law in2012-> Independent ex ante evaluation of fiscal plans to avoid potential deficitbias
  4. 4. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 4Why now?EU15 and the USA: structural budget balance (% GDP)Source: Doménech and García (2013)Deficit bias over last three decades, not only in SpainSpain had an structural deficit similar to othercountries, but with higher volatilityHigh dispersion across countriesHigh persistence-­‐15-­‐10-­‐5051980 1985 1990 1995 2000 2005 2010MediaEspaña
  5. 5. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 5Why now?EU15 and the USA: public debt (% GDP)Source: Doménech and García (2013)A higher structural deficit in the past leads to a higherlevel of public debt in the present ...… with the consequent distortionary and negativeeffects on investment and growthGiven a level of public spending over GDP, a higherlevel of debt requires higher tax rates ...… forcing to maintain a higher primary surplus in thefuture (modified golden rule)10305070901101301501701980 1985 1990 1995 2000 2005 2010MediaEspañad =1+ gr − g(t − g)
  6. 6. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 6Why now?Density function of the effect of 1pp of public debton growthSource: Doménech and García (2013) from Kumar and Woo (2010) and Reinhart and Rogoff (2010)A 10 PP increase in the debt to GDP ratio implies 2decimal points of ess growthCausality problem: To what extent a lower potentialgrowth leads to more public debt?There is some evidence of non-linearities. The effectsare quantitatively more important from debt levelsabove 60%-90%In 92% cases the estimated coefficient is negative. A10pp reduction in the debt ratio leads to an increase inlong-term GDP by 0.8%Solo en un 8%de los casos elcoeficiente espositivoReinhart yRogoff (2010)0.043
  7. 7. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 7Why now?Effects of public debt reduction from 95% to 35% ofGDPSource: Doménech and García (2013)According to current forecasts, public debt will stabilisearound levels close to 100%For each 10 pp of debt reduction GDP increases by0.87% (0.8% Kumar and Woo, 0.7% Elmendorf andMankiw)Tax rates vary to ensure debt sustainabilitySteady state change: debt 95% (2014)to 35% (minimum level before the crisis)GDPPrivate ConsumptionInvestmentEmploymentCapital stockTax rates
  8. 8. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 8Needed (1): macroeconomic and fiscal forecastsIn order to asses the current and future fiscal stance, independentmacroeconomic and fiscal forecasts are needed… and their effects on tax bases, public revenues, expenditures and thebudget balanceNot only about basic macroeconomic and fiscal variables, but also with anassessment of potential macroeconomic imbalances …For different reasons (CAB decomposition, sustainability of the pensionsystem), the forecasting period should be longer than for the StabilityProgramme
  9. 9. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 9Needed (2): methodology to compute trend components(1) Decomposition of GDP and unemployment rates into structural andcyclical components(1) and (2) -> decomposition of taxes bases, revenues, expenditures andthe budget balance into structural and cyclical components(2) Estimates of revenues and expenditures elasticities(1) and (2) are subject to many problems and shortcomings
  10. 10. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 10Problem (1): bias in government forecastsForecasted versus actual output gapSource: Jonung and Larch (2006)Evidence (e.g., Jonung and Larch, 2006, Frankel andSchreger 2013, and others) that EMU governmentsproduce biased forecasts of economic activity ...Would an independent forecasting authority make adifference? Yes, according to the evidence (e.g., Jonungand Larch, 2006, Frankel and Schreger, 2013)Frankel and Schreger (2013): forecasting bias candefeat fiscal rules… that have played a role in generating excessivedeficits-4-3-2-1012345-4 -3 -2 -1 0 1 2 3 4 5One-yearaheadforecastActual output gap
  11. 11. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 11Problem (2): procyclicality of trend componentsUnemployment rate and its structuralcomponent, Spain 1980-2012Source: European CommissionMany ex-post estimates of structural unemploymentare very procyclical …This procyclicality of structural unemployment is themain cause of the procyclicality of potential growthReal time estimates are even more procyclical… even those estimated by independent authorities,such as the European Commsission7%9%11%13%15%17%19%21%23%25%27%1980 1984 1988 1992 1996 2000 2004 2008 2012
  12. 12. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 12Problem (2): procyclicality of trend componentsGrowth of GDP and potential growth,Spain 1981-2012Source: European CommissionEx-post estimates of potential GDP growth are usuallyvery procyclical …Other factors (e.g., working-age population growth)also contribute to this procyclicalityAs in the case of unemployment, real time estimatesare even more procyclicalThe procyclicality of potential growth is not only theconsequence of the procyclicality of structuralunemployment-4%-3%-2%-1%0%1%2%3%4%5%1981 1985 1989 1993 1997 2001 2005 2009
  13. 13. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 13Problem (2): procyclicality of trend componentsGrowth of working-age population, Spain, EMUand USA 1981-2012Source: BBVA ResearchSpain: short-run population forecasts (thousands),resident population, 1st of January each yearSource: BBVA Research based on INE-1.5%-1.0%-0.5%0.0%0.5%1.0%1.5%2.0%2.5%1981 1985 1989 1993 1997 2001 2005 2009USA$EMU$Spain$440004500046000470004800049000500002007 2009 2011 2013 2015 2017 2019 20212007-15 2008-182009-19 2010-202011-21 2012-22
  14. 14. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 14Problem (3): changes in tax bases and elasticitiesUnemployment rat and total public revenues over GDP,Spain 1987-2012Source: BBVA ResearchLarge movements in tax bases and public revenuesthat are related to changes in asset prices or in demandand/or sectorial compositionDiscretionary vs. cyclical changes, transitory vs.permanent, composition and price effects, etc.Example, boom from 2003 to 2007 and crisis from2007 to 2009: public revenues from 41% to 35%The procyclicality of potential growth is not only theconsequence of the procyclicality of structuralunemployment878889909192 939495969798990001020304050607080910111235363738394041427 9 11 13 15 17 19 21 23 25 27Publicrevenues(%GDP)Unemployment rate (%)
  15. 15. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 15808182838485868788899091 92939495969798990001 0203040506070809101112(f)12e6e-12-10-8-6-4-20247 9 11 13 15 17 19 21 23 25 27Budgetbalance(%GDP)Unemployment rate (%)1.7%%&5.9%%21.67%%(2012)%10.96%%(2006)%18%%(2012)%&3%%Problem (4): implications for fiscal policy evaluationUnemployment and budget balance,Spain 1980-2012Source: BBVA ResearchThe structural budget deficit estimatedby the EC is also procyclicalIt is crucial that an independent fiscal authority couldasses the fiscal stance properlyLarger structural deficits in the boom and smaller in thecrisis than the ones estimated by the ECAlternative estimates of the structural unemploymentrate produce less procyclical structural budgetbalances
  16. 16. Macroeconomic Forecasting and the Sustainability of Public FinancesMay, 2013Page 16Main messages123In order to asses the current and future fiscal stance, an independent assessmentof forecasts is needed to avoid the deficit bias of government forecastsForecasts of macroeconomic and fiscal variables, but also with an assessment ofpotential macroeconomic imbalances, and their effects on the budget balanceAlso needed a methodology to compute structural components of publicaccounts (cyclical position and elasticities)Many forecasting and measurement problems: some are well-known, others areless well-known (real time analysis, asset prices and bubbles, changes in demandand sectorial composition, etc.)Fiscal policy in practice is as much art as science … but science is quite useful!(as Blinder, 1997, on the dark art of monetary policy)45
  17. 17. Macroeconomic Forecasting and theSustainability of Public FinancesRafael DoménechAn Independent Fiscal Responsibility Authority For SpainIEF, Madrid, May 13-14, 2013

×