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The Cyclical Adjustment of Government Budgets: Quality and Applications

woensdag, 12 september, 2012 - 18:00
Campus: Brussels Humanities, Sciences & Engineering campus
Faculteit: Social Sciences and Solvay Business School
Jesse De Wit

The Treaty of Maastricht required that EU member states’ deficits be kept below 3% of output
and the Stability and Growth Pact essentially maintained this budget norm. However,
experiences prove that government balances are deficient fiscal targets. Hence, the newly
enacted Fiscal Compact additionally stipulates that deficits, corrected for cyclical fluctuations
and one-off operations, shall not be below 0.5% of output. The adjustment for the business cycle
allows for automatic fiscal stabilizers and the exclusion of one-off operations avoids windowdressing
gimmickry. By this manner, the cyclically-adjusted primary budget (capb) has become
the prime fiscal indicator after decades of methodological abundance concerning cyclical

This study examines the reliability, accuracy and unbiasedness of the cyclically-adjusted primary
budget and its two major input data (the output gap and the primary budget) for 19 countries as
published in the OECD Economic Outlook. Both input data and consequently also the capb
suffer from important revisions. We conclude that the publication choice of the capb matters for
public finance researchers. As to the forecasts, the current-year capb’s are acceptable, but their
quality deteriorates with the forecast horizon. Furthermore, we analyze to what extent estimates
of the OECD, the International Monetary Fund, the European Commission and the European
Central Bank show similar fiscal stances. Despite some differences between the series, their
correlations satisfy.

We exploit then the publication timing in fiscal reaction functions. Voted budgets in OECD-19
respond pro-cyclically to predicted output developments, but their true outcome rather points to
a-cyclicality. Discriminating for EMU-membership, euro countries loosen their fiscal positions
when facing negative growth surprises during the budget process, whereas they do not react on a
more favorable growth. For the other OECD-countries, fiscal stances tend to strengthen with
positive growth surprises. Finally, we trace the effects of fiscal consolidations on economic
growth. Depending on the publication choice, we generate different fiscal multipliers with
opposite signs. Fiscal consolidations in the euro area induce an immediate growth loss, which
differs statistically significant from output developments in other OECD-countries.

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