Over-optimism in Forecasts by Official Budget Agencies and Its Implications

Abstract

The paper studies forecasts of real growth rates and budget balances made by official government agencies among 33 countries. In general, the forecasts are found: (i) to have a positive average bias, (ii) to be more biased in booms, and (iii) to be even more biased at the 3-year horizon than at shorter horizons. This over-optimism in official forecasts can help explain excessive budget deficits, especially the failure to run surpluses during periods of high output: if a boom is forecasted to last indefinitely, retrenchment is treated as unnecessary. Many believe that better fiscal policy can be obtained by means of rules such as ceilings for the deficit or, better yet, the structural deficit. But we also find: (iv) countries subject to a budget rule, in the form of euroland's Stability and Growth Pact (SGP), make official forecasts of growth and budget deficits that are even more biased and more correlated with booms than do other countries. This effect may help explain frequent violations of the SGP. The question becomes how to overcome governments' tendency to satisfy fiscal targets by wishful thinking rather than by action. Chile in 2000 created structural budget institutions that may have solved the problem. Independent expert panels, insulated from political pressures, are responsible for estimating the long-run trends that determine whether a given deficit is deemed structural or cyclical. The result is that Chile's official forecasts of growth and the budget have not been overly optimistic, even in booms. Unlike many countries in the North, Chile took advantage of the 2002-7 expansion to run budget surpluses, and so was able to ease in the 2008-9 recession.

Does fiscal responsibility matter? Evidence from public and private forecasters in Italy

“…This result differs from that obtained by Merola and Pérez (2013), who found the good times dummy to be positive and significant, but is in line with those of Frankel (2011) and Frankel and Schreger (2013), who found that official forecasts were especially subject to wishful thinking during booms.…”

“…This result is consistent with the previous literature, which has found that the optimistic bias of public forecasts tends to increase as the horizon lengthens (Frankel, 2011;Frankel & Schreger, 2013, 2016. One reason for this might be an upward bias in GDP growth forecasts due to governments using GDP forecasts in a strategic manner.…”

“…Frankel (2011) and Frankel andSchreger (2013, 2016) found evidence that numerical fiscal rules, such as those included in the Stability and Growth Pact, tend to increase the biasedness of the official forecasts of growth and budget deficits, as they provide an additional incentive for governments' tendency to satisfy fiscal targets by wishful thinking. On the other hand, other types of rules at the national level, such as the creation of an independent fiscal institution that provides independent forecasts, may reduce the bias in forecasts.…”

Fiscal forecasts and political systems: a legislative budgeting perspective

“…20 There is, besides, no obligation for budgetary projections, which are always produced by governments and only occasionally assessed by a fiscal council, because the ''comply or explain'' principle is not compulsory. Finally, no EU country employs macro projections from a panel of private sector forecasters, a more definite solution to insulate official forecasts from executive/legislature strategic interactions (Frankel 2011;Frankel and Schreger 2014).…”

Informing policy makers about future health spending: A comparative analysis of forecasting methods in OECD countries

“…It is worth noting that the subset of models that relies on forecasts of GDP growth as a driver of health expenditure are subject to the potential error within those forecasts [54].…”