IMF Working Papers

Identifying Fiscal Policy Transmission in Stochastic Debt Forecasts

Author/Editor:

Kei Kawakami ; Rafael Romeu

Publication Date:

May 1, 2011

Electronic Access:

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Summary:

A stochastic debt forecasting framework is presented where projected debt distributions reflect both the joint realization of the fiscal policy reaction to contemporaneous stochastic macroeconomic projections, and also the second-round effects of fiscal policy on macroeconomic projections. The forecasting framework thus reflects the impact of the primary balance on the forecast of macro aggregates. Previously-developed forecasting algorithms that do not incorporate these second-round effects are shown to have systematic forecast errors. Evidence suggests that the second-round effects have statistically and economically significant impacts on the direction and dispersion of the debt-to-GDP forecasts. For example, a positive structural primary balance shock lowers the domestic real interest rate, in turn raising GDP and lowering the median debt-to-GDP projection by an additional 10 percent of GDP in the medium term relative to prior forecasting algorithms. In addition, the framework employs a new long-term (five decade) data base and accounts for parameter uncertainty, and for potentially non-normally distributed shocks.

Series:

Working Paper No. 2011/107

Subject:

Financial services Fiscal policy Fiscal stance Output gap Production Production growth Real interest rates

Frequency:

Annually