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N° 2007-10 |
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| May 2007 |
| Fiscal Policy in Real Time |
| Jacopo
Cimadomo |
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Most of the empirical literature on fiscal policy has found that, over the post-World War II
period, governments in developing and industrialized countries have reacted “pro-cyclically” to fluctuations in the economic activity (see e.g. Lane (2003) and Kaminsky, Reinhart and
Vegh (2004)). Otherwise stated, budgetary decisions such as tax increases and cuts in public
spending implemented in “bad times” would have tended to aggravate the length and the
severity of economic recessions. On the other side, expansive policies put in place during
“good times” would have led economic booms to be more prolonged and vigorous.
This empirical evidence has been mainly drawn from the estimation of fiscal policy reaction
functions, relating a policy indicator to the output gap and other explanatory variables, based
on the use of revised data, i.e. data available in an “updated” form to the econometrician at the
time the study is carried out. Since many economic variable are seriously contaminated by
revision errors, however, revised data may be substantially different from the ones available
in “real-time” to policymakers at the time of budgeting. In other words, as shown by Orphanides
(2001) in the framework of monetary policy analysis, unrealistic assumptions about
the timeliness of data availability may induce misleading assessments on the historical policy
stance. Nevertheless, although informational problems clearly matter also for the evaluation
of the fiscal policy stance, little has been done in this field.
In the present study we show that, when the object of interest is intentional stance of fiscal
policy, real-time information on all the variables included in a fiscal policy rule should be
employed. In particular, it is highlighted that the use of real-time observations on the fiscal
policy “instrument” itself, typically the structural primary balance, may be of key importance.
In fact, and in contrast with central bankers who can control their operating instrument, the
short-term interest rate, with great precision, the actual realization of planned fiscal measures
may depend on several factors outside the direct control of fiscal authorities. Hence, there
might be sizeable differences between discretionary fiscal measures as planned in the past
and what it is observed ex-post, for the same years.
Based on a dataset of revised and real-time observations drawn from the December Issues of
the OECD Economic Outlook for 19 industrialized countries, from 1994 to 2006, it is shown
that the stance of fiscal policy seems to be pro-cyclical, if evaluated ex-post. When real-time
data are used in the estimation of fiscal policy rules, however, the ex-ante stance appears to
be counter-cyclical, especially during buoyant economic times. The analytical form of the
bias incurred in evaluating the intentional stance of the policy using revised data is formally
derived. It is demonstrated that the size and the sign of that bias can be accurately predicted,
based on empirical second-order moments of revisions errors in the variables of interest.
Finally, the possible presence of non-linearities in the way the discretionary component of
fiscal policy reacts to the economic cycle and debt accumulation is tested. It emerges that
the intentional behavior of fiscal policy is characterized by two regimes, and that the switch
between them, from a neutral or slightly pro-cyclical stance to a counter-cyclical one, is likely
to occur when output is close to its potential level. However, the hypothesis of threshold
effects is always rejected when the analysis is based on revised data. |
Non-technical summary |
Résumé
non-technique
en français  |
Full text
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| Fiscal policy; real-time data; revision errors; endogenous threshold models |
Keywords |
| C23, E30, E62, H30 |
JEL classification |
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