2/2007 Andrew Hughes Hallett, Rasmus Kattai and John Lewis. Early warning or just wise after the event? The problem of using cyclically adjusted budget deficits for fiscal surveillance

Working Papers of Eesti Pank. No 2/2007. Andrew Hughes Hallett1, Rasmus Kattai2 and John Lewis3

The effectiveness of cyclically adjusted balances (CABs) as an indicator of the health of public finances depends on the accuracy with which cyclically adjusted figures can be calculated in real time. This paper measures the accuracy of such figures using a specially constructed real time dataset containing published values of deficits, output gaps and cyclically adjusted deficits from successive issues of OECD economic outlook. We find that data revisions are so great that real-time CABs have low power in detecting fiscal slippages as defined by the ex post data.
JEL Code: H62, H68
Key words: fiscal surveillance, cyclically adjusted budget balance, real time data

* The authors are grateful to the DNB's visiting scholar programme for enabling Rasmus Kattai to visit the DNB to work on this paper. This paper would not have been possible without the painstaking work of others in compiling the real time dataset. We thank Massimo Giuliodori of the University of Amsterdam for allowing us to use the dataset he assembled, and Peter Keus of De Nederlandsche Bank for his work in collating an additional dataset. We thank seminar participants at the University of Amsterdam for useful comments. The views expressed in this paper are those of the authors and not necessarily those of De Nederlandsche Bank or the Bank of Estonia.
1 George Mason University, School of Public Policy, 4400 University Drive, Fairfax, VA 22030, US; ahughesh [at] gmu.edu.
2 Research Department, Bank of Estonia, Estonia Pst 15, 15095, Tallinn, Estonia; rkattai [at] epbe.ee.
3 Economics and Research Division, De Nederlandsche Bank, Postbus 98, 1000AB, Amsterdam, The Netherlands; j.lewis [at] dnb.nl.

Contents

1. Introduction
2. The model
2.1. Actual and potential output
2.2. Setting fiscal policy
3. Real time versus ex post data: what's the difference?
3.1. The real time dataset
3.2. Output gaps across vintages
3.3. Budget balances across vintages
3.4. Robustness of CAB estimates over time
4. Assessing the OECDs figures against a simple benchmark
5. The effectiveness of CABs as an early warning indicator
5.1. Can CABs sound the alarm in real time?
5.2. Deficit revisions or problems with cyclical adjustment?
5.3. Data revisions and fiscal slippages: is there a link?
6. Conclusions
References
Appendices

Early Warning or Just Wise After the Event? The Problem of Using Cyclically Adjusted Budget Deficits for Fiscal Surveillance, Working Papers of Eesti Pank No 2/ 2007 (PDF*)

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