Identifying Fiscal Policy Transmission in Stochastic Debt Forecasts

Kei Kawakami and Rafael Romeu ()

No 2011/107, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; interest rate; real GDP; mn mathvariant; Debt sustainability; forecasting; Brazil; IMF; reaction function; fiscal policy feedback; motion equation; transmission identification; forecasting framework; debt projection; simulation model; debt sustainability fan; baseline debt; forecasted debt decline; debt reduction effects; stochastic debt forecasting framework; Fiscal stance; Real interest rates; Production growth; Output gap; Global (search for similar items in EconPapers)
Pages: 35
Date: 2011-05-01
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Citations: View citations in EconPapers (11)

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