25/08/2011: National forecasts and systemic upward biases

New research, published today by NBER shows that national growth and budget forecasts in the Euro area tend to overestimate growth and revenue stability than in other advanced economies and are prone to provide more biased estimates in the period of economic expansion.

The paper, titled Over-optimism in Forecasts by Official Budget Agencies and Its Implications, and authored by Jeffrey A. Frankel of the Kennedy School of Government, Harvard University and published as NBER Working paper 17239 (link here):
"... 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, (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."

In contradiction to the Franco-German recent mantra on fixed and centralized budgetary systems, the author states that: "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 Path, 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."

In contrast, own budgetary discipline and honesty in forecasts pays off: "One country, Chile, has managed to overcome governments’ tendency to satisfy fiscal targets by wishful thinking rather than by action. As a result of budget institutions created in 2000, 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 2002-07 expansion to run budget surpluses, and so was able to ease in the 2008-09 recession."