DP6213 Early Warning or Just Wise After the Event? The Problem of Using Cyclically Adjusted Budget Deficits for Fiscal Surveillance

Author(s): Andrew Hughes Hallett , Rasmus Kattai , John Lewis

Publication Date: March 2007

Keyword(s): Cyclically Adjusted Budget Deficits , False and Missed Alarms , Potential Output , Real Time Data

JEL(s): C82 , E62 , H62

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6213.asp.asp

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 data set containing published values of deficits, output gaps and cyclically adjusted deficits from successive issues of the OECD's 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. We find that around half the real time errors in CABs can be attributed to revisions in the cyclical component of the budget balance, and around one half to revisions in the deficit to GDP ratio across vintages. Our results are consistent with the conjecture that policy makers have presented favourable estimates of their fiscal position in order to reduce scrutiny or the probability of sanctions for lax behaviour.