Structural Budget Balance Research Articles

Government debt forecast errors and the net expenditure rule in EU countries: Undue optimism at a cost

Against a backdrop of debt ratio targets being central to recent proposed changes to the EU fiscal rules, we examine errors in official forecasts of the General Government debt ratios and their determinants in 26 member states from 2012 to 2019 when the “six pack” rules applied. We find debt ratio outturns exceeding projected values with forecast errors increasing over a four-year horizon. Larger errors arise where the initial debt ratio exceeds the Maastricht Treaty threshold of 60 per cent. In modelling the forecast errors of the debt ratio, we find that most of the variation is explained by forecast errors in the output growth rate and in the structural budget balance, as well as previous errors in projecting the debt ratio. During the sample period, member states who had not met their medium-term objective of a balanced structural budget were expected to adhere to a net expenditure rule. For countries subject to this requirement, we find undue optimism arising in forecasting the deficit ratio, a determinant of the debt ratio. The implications of these findings for EU policymakers and, in particular, forecasters are considered.

Effectiveness and counter‐cyclicality of fiscal consolidation under compliance regulation: The case of the Stability and Growth Pact

AbstractIn this study we examine the impact of the European Stability and Growth Pact (SGP) on narratively identified fiscal adjustments whose prime focus is to reduce the budget deficit and compare the effects with those on the primary and the structural budget balance. The cross section of EU and non‐EU economies and the sample period 1980–2014 allow for an assessment of the SGP regarding its effectiveness, cyclicality, and the type of fiscal adjustments (tax hikes vs. spending cuts) as compared with counterfactual scenarios. Our findings indicate that the SGP has effectively boosted budget consolidation measures identified by means of the narrative approach, whereas it had no overall impact on the primary and an overall minor impact on the structural budget balance. However, the effectiveness of the SGP has varied considerably over time. All measures indicate that the SGP was particularly effective in the period after the introduction of the Euro, except for the 2 years following the financial crisis in 2008. We find no evidence that fiscal policy has become more procyclical under the SGP. Finally, fiscal consolidation under the SGP favors spending cuts, whereas the application of tax hikes shows no sizeable differences as compared with the reference group.

Fiscal policy rules and economic fluctuations in the countries of the West African Economic and Monetary Union (WAEMU)

• Fiscal policies did not fix the increase in the stock of debt. • Fiscal policy is countercyclical during recessions and acyclic during expansions with respect to the fiscal rule on the overall budget balance, including grants. • The fiscal policy stance is pro-cyclical under the structural budget balance, including grants. • During expansions, the implementation of multilateral surveillance has a counter-cyclical effect regardless of the rule applied. • During a recession, multilateral surveillance reinforces pro-cyclicality.

Official fiscal forecasts in EU member states under the European Semester and Fiscal Compact – An empirical assessment

The efficacy of official forecasts in the EU has been under the spotlight since the introduction of the euro, with biases widely reported prior to the 2008–12 financial and sovereign bond market crisis. Changes to the EU fiscal rules and procedures, in the form of the European Semester and Fiscal Compact, in the early 2010s were adopted to improve forecasting, including through providing a role for independent fiscal institutions. Using data for 22 countries between 2013 and 2019, this paper shows that, despite these changes, biases, of a pessimistic form, remain in forecasts of budget balance and output variables in Stability and Convergence Programmes and the European Commission's Spring Forecasts. Econometric analysis indicates forecast errors in both the headline budget balance and the structural budget balance being explained by forecast errors in output variables and by EU fiscal rule requirements. Member states under an excessive deficit procedure provide optimistic headline budget balance forecasts compared to non-EDP countries, while those that have not met their medium-term objective report smaller forecast errors for the structural budget balance. Independent fiscal institutions are linked to a smaller bias to forecasts of the structural budget balance but have no effect on the forecast errors of the headline budget balance.

Formation of Long-Term Fiscal Sustainability of Kazakhstan Using the Rule Structural Budget Balance

The purpose of the study is to substantiate the potential of using the results of modeling potential GDP and estimating the output gap to comply with fiscal rules that are adequate for the corresponding economic cycle of the economy of Kazakhstan. The methods of economic, statistical, graphical, system, functional analysis, economic and mathematical modeling are applied. To achieve this goal, the analysis of Kazakhstan’s fiscal stability was carried out based on the assessment of Kazakhstan’s potential GDP and the calculation of output gaps, which were carried out based on the dynamic series method of the reported real GDP in 2005 prices for 1991-2019 using the Hodrick-Prescott filter (CP) using the EViews 10 econometric package. The current mechanism for using the output gap indicator in Kazakhstan’s fiscal policy does not have sufficient flexibility. For a timely response of the budget system to changes in the economic situation in the country or abroad, considering the output gap, it is important to introduce an automatic adjustment system that can eliminate contradictions and inconsistencies when making macroeconomic policy decisions by the main regulator and the government of the country. To do this, there is a need to revise the existing fiscal policy based on building a system of new budget rules on countercyclical principles. The proposed alternative fiscal model with the introduction of the rule on the structural balance of the budget is aimed at ensuring long-term fiscal stability, which does not allow for a pro-cyclical policy.

Potential GDP Modeling and Output Gap Estimation as a Basis for Countercyclical Fiscal Policy in Kazakhstan.

This paper identifies key risks of the public sector in Kazakhstan. Methods for modeling potential output and output gap in international research practice and their application in countercyclical fiscal policy are considered. The potential output of Kazakhstan is retrospectively analyzed using the Hodrick–Prescott (HP) filter. Periods of the procyclical budgetary policy are identified. It is proposed to introduce a fiscal model of the structural budget balance, to target a zero output gap in the short term, and to increase the potential output through structural reforms.

Structural Budget Balance as a Fiscal Rule in the European Union—Good, Bad, or Ugly?

The EU's Fiscal Compact requires member states to legislate structural budget balance rule(s) (SBR). We use elite interviews and government documents from Austria, Ireland, and Portugal to assess the extent to which SBRs are perceived to have resulted in improved accountability, coordination, and credible commitment on the part of elected officials. We find that establishing the SBRs in legislation has not resulted in domestic ownership on the part of the member states. Furthermore, SBRs do not appear to have improved accountability due to questions about their accuracy. There is some evidence that SBRs aid finance ministries' coordination efforts.

A BRIEF STUDY OF THE IMPACT OF THE FINANCIAL CRISIS OF 2008 ON THE FISCAL POLICY OF THE USA

This study aimed to evaluate the impact of the financial crisis of 2008 on the fiscal policy of the USA from 2004 to 2012. The study found that this crisis had a significant effect on the USA fiscal policy. More clearly, the USA budget balance as an indicator of fiscal policy and its structural budget balance as an indicator of discretionary fiscal policy had changed seriously during this period. The study also reveals that during the years (2007-2012), the USA government used a countercyclical and an expansionary fiscal policy as a whole and as discretionary measures. To face such crisis and mitigate its effects, the study recommends that with the using of the fiscal policy and discretionary measures, it is better for the USA government to activate automatic stabilizers measures. In addition, to use other policies especially monetary policy and with the fiscal policy in the same direction.

Political Budget Cycles in the European Union: New Evidence of Fragmentation*

This paper deals with the possible existence of political budget cycles (PBCs) within the European Union (EU). I use panel data for 28 EU countries from 1995 to 2016 and provide estimates based on dynamic panel regressions. I employ a system-GMM estimator complemented by the Principal Component Analysis (PCA) to limit the number of instruments. The specifications include structural budget balances related to the potential GDP, thereby limiting the initial endogeneity. These measures capture the true motivation behind fiscal policies. The results suggest that the EU member states exhibit PBCs: (i) the intervention occurs in the year before elections and (ii) the structural budget balance to the potential GDP ratio is lower by −0.41 percentage points a year before elections. In addition, I have investigated the EU fragmentation in terms of the PBCs and selected 8 countries’ characteristics correlating to the existence of these cycles. These include lower GDP per capita, post-communist background, low tax burden, high perceived corruption, low levels of media freedom and internet usage, lower number of directly voted-in legislative officials, and a low parliamentary voter turnout.

Can an Increase of Infrastructure Spending Contribute to Higher Potential Output in the Medium and Longer Term?

This discussion on recent economic literature concerns some issues on potential output and related policy implications. It is not clear to what extent potential output growth has been affected by the recent crisis. Then the actual stabilization policies—based on the existence of output gaps and public debt sustainability—might not be appropriate to mitigate effectively cyclical fluctuations and to stimulate economic growth. The recent empirical evidence on the determinants of potential output—i.e. the origin of cyclical fluctuations—leads to a higher uncertainty on potential output measurement. Moreover the existing methods to estimate potential output present some weaknesses reducing reliability of the estimation results. Focusing on European case, the measure of potential output is considered as an useful guidance for policy. In particular, Stability and Growth Pact and Treaty on Stability, Coordination and Governance in the Economic and Monetary Union refer to the concepts of potential output, output gap and structural budget balance. Recently academics and some policy makers have criticized these measures and the related austerity policy because they worsened the economic situation. According to recent theoretical and empirical contributions it is important to rethink at the role of fiscal policy, focusing on fiscal stimulus and in particular on additional infrastructure spending because it can positively affect GDP as well as potential output. A part of this literature discusses extensively how public capital affects the economy. Under certain conditions such as a good institutional framework and sound projects, a higher spending on public infrastructure has a high economic impact.

The performativity of potential output: pro-cyclicality and path dependency in coordinating European fiscal policies

ABSTRACTThis paper analyzes the performative impact of the European Commission's model for estimating ‘potential output’, which is used as a yardstick for measuring the ‘structural budget balance’ of EU countries and, hence, is crucial for coordinating European fiscal policies. In pre-crisis years, potential output estimates promoted the build-up of private debt, housing bubbles and macroeconomic imbalances. After the financial crisis, these model estimates were revised downwards, which increased fiscal consolidation pressures. By focusing on the euro area's economies during 1999–2014, we show how the model's estimates influence actual economic outcomes. We identify two major economic impacts of the potential output model. First, the political implications of the model led to pro-cyclical feedback loops, reinforcing prevailing economic developments. Second, the model has contributed to national lock-ins on path dependent debt trajectories, fueling ‘structural polarization’ between core and periphery countries.

The NAIRU determinants: What’s structural about unemployment in Europe?

This paper analyzes the determinants of the European Commission’s estimates of the non-accelerating inflation rate of unemployment (NAIRU) for 14 European countries during 1985–2012. The NAIRU is a poor proxy for ‘structural unemployment’. Labor market institutions – employment protection legislation, union density, tax wedge, minimum wages – underperform in explaining the NAIRU, while cyclical variables – capital accumulation and boom-bust patterns in housing markets – play an important role. This finding is policy-relevant since the NAIRU is used to compute potential output and structural budget balances and, hence, has a direct impact on scope and evaluation of fiscal policies in Europe.

Does the Structural Budget Balance Guide Fiscal Policy Pro-Cyclically? Evidence from the Finnish Great Depression of the 1990s

In this article, I evaluate the challenges related to the European Commission's output gap method of calculating the structural budgetary position, and assess its bottom-up alternatives in the EU's fiscal framework using the Finnish data for the years 1984–2014. The results reinforce the impression of the limited capacity of the output gap method to predict cyclical changes in real time and suggest that using the output gap method to steer fiscal policy tends to lead to a procyclical policy (stimulus in upturns and austerity in downturns). The bottom-up assessment methods that are based on discretionary fiscal policy measures appear to work better, and using them to steer fiscal policy could make the policy more effective.

The Performativity of Potential Output: Pro-Cyclicality and Path Dependency in Coordinating European Fiscal Policies

This paper analyzes the performative impact of the European Commission’s model for estimating ‘potential output’, which is used as a yardstick for measuring the ‘structural budget balance’ of EU countries and, hence, is crucial for coordinating European fiscal policies. In pre-crisis years, potential output estimates amplified the build-up of private debt, housing bubbles and macroeconomic imbalances. After the financial crisis, they were revised downwards, which increased fiscal consolidation pressures. By focusing on the euro area’s economies during 1999-2014, we identify two performative aspects of the potential output model. First, the political implications of the model led to a pro-cyclical feedback loop, reinforcing general economic developments. Second, the model has contributed to national lock-ins on path dependent debt trajectories, fueling ‘structural polarization’ between core and periphery.

Evaluating Fiscal Performance in Latin America and the Caribbean: Structural Balance Estimates from an Original Dataset

In recent years, an increasing number of countries have began anchoring their fiscal policy frameworks in terms of rules that target the cyclically adjusted or structural (as opposed to actual) balance in an effort to overcome problems of procyclicality and fiscal volatility. The logic for doing so is in principle compelling: rule-based fiscal policies allow automatic stabilizers to work freely during the cycle and help accumulate fiscal surpluses in good times. However, the estimation of structural balances is subject to a number of methodological challenges, including the degree of estimation uncertainty. This paper presents a range of estimates of the structural budget balance and uses them to analyze the cyclical behavior of fiscal policy in Latin America and the Caribbean. Based on an original dataset comprising detailed fiscal information from 20 countries across the region between 1990 and 2014, the paper finds that the range of estimates can be large for some countries, especially those that derive substantial fiscal revenue from commodity-related activities. In addition, the evidence shows that on average, the region has followed a procyclical policy pattern: a 1 percent increase in the output gap is associated with up to a 0.55 percentage point deterioration in the structural primary balance. This pattern hides substantial regional heterogeneity: procyclicality is more marked in countries that face large terms of trade shocks, but it can be counteracted by higher institutional quality.

The Sustainability of Public Finances in Republic of Moldova Under EU Fiscal Rules

This paper analyses public finances sustainability in the Republic of Moldova under the European Union fiscal rules, by estimating the structural budget balance indicator using a three steps methodology. We concluded that, except for 2009, the Republic of Moldova complies with the Maastricht numerical fiscal rule; however it does not comply with the new fiscal rules regarding the structural deficit and public expenditures growth that had been set by the Fiscal Compact. The fact that budget deficits and public debt had been sustainable was mainly because of the concessions made by the external creditors in restructuring the public debt and was not a merit of national government. Moreover, since the regular budget deficit and the structural one tell different stories, we strongly advocate for using the latter in order to complement the existing data with a medium-term budgetary view.

The Sustainability of Public Finances in Republic of Moldova Under EU Fiscal Rules

This paper analyses public finances sustainability in the Republic of Moldova under the European Union fiscal rules, by estimating the structural budget balance indicator using a three steps methodology. We concluded that, except for 2009, the Republic of Moldova complies with the Maastricht numerical fiscal rule; however it does not comply with the new fiscal rules regarding the structural deficit and public expenditures growth that had been set by the Fiscal Compact. The fact that budget deficits and public debt had been sustainable was mainly because of the concessions made by the external creditors in restructuring the public debt and was not a merit of national government. Moreover, since the regular budget deficit and the structural one tell different stories, we strongly advocate for using the latter in order to complement the existing data with a medium-term budgetary view.

Output-Gaps in the PIIGS Economies: An Ingredient of a Greek Tragedy

The Fiscal Compact has created new responsibilities in terms of quantitative measures of excess demand in the economy. The concept of structural budget balance is dependent on cycle values. As a consequence one of the primary responsibilities of economics is to build a good indicator of the magnitude of short term disequilibrium. Knowledge of the magnitude of the excess demand in the economy is essential for an appropriate application of the Fiscal Compact. The usual empirical concepts of output gap are not sufficiently well designed to give an accurate view of the negative excess demand when there are output breaks in the economy. The information produced by different (quasi-) official output gaps is quite often misleading, contributing to a rise in the unemployment rate. We propose a solution that might contribute to solve this problem that is clearly a crucial one for the PIIGS in times of crisis.

Some New Results on the Estimation of Structural Budget Balance for Spain

The recession that started in 2008 caused a sharp deterioration of the budget balance of Spain. This de-cline was not fully anticipated by the structural budget balance due to some methodology limitations.In this article, we calculate an alternative structural balance for Spain in the years prior to the subprimecrisis that includes residential investment as an explanatory variable. This estimate shows that by 2004the Spanish fiscal situation was not as strong as presumed. This fragility was hidden by the extraordi-nary revenue from the real estate bubble and the construction boom.

Measuring Indebtedness of Greece, Italy, Portugal and Spain, (GIPS), in Terms of General Government Net Lending/borrowing, General Government Net Debt, Current Account Balance, Total Investment, Gross National Savings, General Government Structural Balance and Output Gap.

This article measures the total government indebtedness, total investment and gross national savings of Greece, Italy, Portugal, and Spain, (GIPS). Using data from the International Monetary Fund, IMF, we describe the current situation for the period 2000 to 2018. Macroeconomic indicators such as general government net lending/ borrowing, general government net debt, current account balance, total investment, gross national savings, general government structural balance and output gap would be used to show the government’s budget deficit and the monetary fluctuations. A distinction would be made between the cyclically – adjusted government budget balance and the structural budget balance. The purpose of this article is to show how government budgets could eliminate and stop poverty by stimulating investment and developing the infrastructure through gross national savings and taxation. Implementation of an equitable progressive income taxation system would be achieved in combination with the Greek Orthodox approach that redistributes incomes to the poors, the prostitutes, the beggars or any person that is financially underrepresented in the society. In other words, the effort will be to accumulate in the central bank reserves around 100 trillions of four different currencies, namely, EURO, GBP, USD and AUD. Greece should also keep around 800 trillions reserves in Drachmas as a sign of respect for the Greek citizens. Government surpluses of 100 trillions without involving any borrowing will aim to achieve equilibrium by avoiding that someone will become better-off and someone else worse-off. We want marginal social benefit to equal marginal social cost by integrating the Greek Orthodox principles in the daily routines of the households and the politicians. The prerequisite to achieve the above is to establish first class communication and collaboration between the Orthodox Church, the government and the households.