Wednesday, August 10, 2016
Government fiscal forecasts invoke considerable skepticism: Frankel (2012), for instance, calls them “wishful thinking” and advocates the use of private forecasts as a reality check. This recommendation leads to an obvious question: how good are the private sector’s fiscal forecasts? We assess the quality of forecasts of the government budget balance made by the private sector for nine advanced economies between 1993 and 2013, with a special focus on the Great Recession period. Our main findings can be summarized as follows. First, we show that private sector budget balance forecasts typically display bias towards ‘optimism’ but the extent of the bias differs across countries. Second, we find that budget balance forecasts exhibit ‘information rigidity’; that is, revisions to forecasts tend to be smooth. This tendency proves costly around turning points in the economy, which we illustrate here using the forecast errors made during the Great Recession. To conclude, while it is a good idea to complement government fiscal forecasts with those from the private sector, there are steps that the private sector could also take to improve the quality of its own forecasts.
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