Economics
Cyclically Adjusted Budget Balance
The Cyclically Adjusted Budget Balance is a measure that accounts for the impact of economic cycles on government budgets. It adjusts the actual budget balance to reflect what the balance would be under normal economic conditions, thus providing a more accurate assessment of fiscal policy. This helps policymakers make informed decisions by separating the effects of the business cycle from underlying fiscal trends.
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3 Key excerpts on "Cyclically Adjusted Budget Balance"
eBook - ePub- Manmohan Kumar, and Teresa Ter-Minassian(Authors)
- 2007(Publication Date)
- INTERNATIONAL MONETARY FUND(Publisher)
Regardless of the precise option, an assessment of the economic cycle and its impact on the budget is critical to the pursuit of countercyclical policies. In the absence of a reasonably reliable gauge of the state of the cycle and its implications for revenues and expenditures, policy cannot be implemented effectively. Indeed, in these circumstances, it is likely to end up being counterproductive, amplifying the cycle. This raises a number of analytical and operational issues, including the role of automatic stabilizers, which are explored in the following two sections.Cyclically Adjusted Fiscal Balances
A reliable indicator of the cyclical position of the economy and of its impact on the budget is a precondition to promoting countercyclical fiscal policy in good times. It is essential for the design of policy in the first place, but also necessary to monitor outcomes and to hold policymakers accountable. Targeting cyclically adjusted fiscal balances can, in principle, assist in the design and monitoring of policy by focusing on the discretionary component of the budget.The cyclically adjusted fiscal balance (CAB) is obtained by removing the cyclical component of the budget from the nominal fiscal balance. The cyclical component, in turn, depends on two factors: the size of the output gap; and the output elasticity of the budget, which is determined by the extent to which individual budgetary items react to fluctuations in output, as well as by the size of the budget (Box 4.2 ).However, while CABs are regularly used by international organizations and national institutions, budgetary targets are seldom framed in cyclically adjusted terms. This reflects in part the relative complexity of the techniques used for the estimation of output gaps and budgetary elasticities. There are two main issues: (1) different methods for estimating CABs can yield different results; and (2) forecasts and outturns of CABs can be subject to, respectively, large errors and significant revisions, regardless of the specific method used. These issues are examined below.
eBook - PDF- Ľudovít Ódor(Author)
- 2017(Publication Date)
- Cambridge University Press(Publisher)
Dashed lines repre- sent the error bands. These are the 16th and 84th percentiles from Monte Carlo simulations based on 1,000 replications. ΔDC is the percentage point difference in domestic credit scaled by GDP, while CAD is the current account surplus scaled by GDP. GDP is the cycle of the real gross domestic product and FBAL is general government balance scaled by GDP. with the presence of a ‘voracity effect’, whereby the political equilib- rium response to a increase in revenues is a more-than-proportionate increase in public spending, as is laid out in Tornell and Lane (1999). Taken together, Figures 12.1–12.3 suggest that the fiscal dynamics generated by shocks in financial cycles are mainly driven by govern- ment expenditure. This suggests that political economy mechanisms are at work in relation to the discretionary component of government spending, such that an exclusive focus on the mechanical impact of financial shocks on tax revenues would be misdirected. So far, we have focused on the aggregate fiscal balance. In Section 2, we provided a set of reasons why it may be preferable to examining the general government balance. Still, we next turn to the cyclically adjusted balance to gain a better understanding of the effects of financial cycle shocks. Since this fiscal indicator already takes into account the GDP cycle, we would expect that it will react less to financial cycle shocks as its response will only capture the orthogonal contribution of these shocks, instead of also including those that operate by shifting GDP. The first row of Figure 12.4 shows the responses of the cyclically adjusted government balance to changes in both financial cycle meas- ures. For a credit shock, the qualitative response of the cyclically adjusted balance is very similar to the one for the unadjusted general government balance. For the current account deficit shock, the response of the cyclically adjusted fiscal balance is also negative.
eBook - ePubFiscal Policy Making in the European Union
An Assessment of Current Practice and Challenges
- Martin Larch, João Nogueira Martins(Authors)
- 2009(Publication Date)
- Routledge(Publisher)
In general, the measure is more volatile than the measures derived with conventional methods (see Figure 5.5, bottom left panel). In many instances, our measure leads the smoothed measures in the direction of change. The fiscal indicator is usually smaller than the cyclically adjusted deficit. This reflects the definition of the structural balance, by which we take out the automatic stabilizers and the induced stabilization effects caused by fiscal policies. In addition, fiscal policy also affects permanent output and therefore the structural fiscal position fluctuates around balance. The indicator is also much more volatile. This follows from the major contribution of supply and fiscal shocks to the variation in output, spending and revenues (Figure 5.4). As we discuss below, one of the causes of this strong volatility – apart from the dominant supply-side shocks – is the pro-cyclical bias that characterizes fiscal policy making that induces extra variation, especially so in government revenues. We may then expect our fiscal measure to coincide with some episodes of fiscal laxness or retrenchment. We consider the budget to undergo a strong expansion (contraction) when the cyclically adjusted primary balance falls (increases) by at least two percentage points of GDP in one year, or at least 1.5 percentage points on average in the last two years. This is the measure proposed by Alesina and Ardagna (1998). In Table 5.5, we gather those fiscal years in which a strong expansion or adjustment has occurred in our dataset (see Afonso 2006). At first sight, the correspondence is rather close. Comparing the changes in Figure 5.5 (bottom left panel) to the years in Table 5.5, we detect all events that the Alesina–Ardagna measure also suggests. For example, we find the budgetary cost of Reunification on German public finances to have been large. The Maastricht rules have also led to considerable fiscal retrenchment in France and Spain
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