ESTIMATING OUTPUT GAPS AND STRUCTURAL FISCAL BALANCES Mario Marcel Sector Manager, Institutional Capacity and Finance, BID XXX Meeting of the Latin American Network of Central Banks and Finance Ministries Washington DC, October 21-23, 2009

What is a structural balance? SB = UB – CEB Where, CEB = (T-T’) – (G-G’) If T = t(Y, …), T-T’ depends on output gap Y-Y’ (Same for G)

Key issues What components of revenues and expenditures are sensitive to the business cycle and to what extent? To estimate SB: –identify a budget aggregate to monitor –Selection of budget components that will need adjustment –To what macro variables are such components sensitive –Elasticities that relate changes in variable with changes in budget components

History of structural balances History of structural balances: –Start with Kaldor 1944 –Neglected chapter of Blinder and Solow (1973) –Currently OECD and IMF All the above establish relationship with output, in developed countries

What a structural balance is NOT? Structural balance is an estimate, not an actual figure Relates economy to budget and not the other way round Structural balance is not a model, but a simple construct

Structural balances as basis for fiscal rules Fiscal Rules: –Preestablished multi-year restriction on fiscal aggregates, constraining fiscal policy decisions (expenditure, overall balance, primary balance, debt) Structural fiscal rules: –Rather recent development –Started with Switzerland and Chile in early 2000s, nearing 10 years of experience –In Chile: survived two deep business cycles –IMF singled it out as the best guide to conduct countercyclical fiscal policy, but warned of required conditions

SB-based fiscal rules issues Advantages: –Cycle-independent, avoid procyclical behavior of fiscal accounts –Concreteness: guidance to medium term expectations on fiscal policy that are eventually realized –Availability: can be regularly estimated and disseminated –Accountability: can be measured, evaluated

SB-based fiscal rules issues Limitations: –Estimate, not directly observed –Relies on key assumptions, subject to manipulation (off-sample assumptions to estimate end-point in trend or potential output) –Not countercyclical in nature. Focus on automatic stabilizers and stability of spending –Cannot respond to every macroeconomic context, best suited for demand-led (Keynesian) business cycles

SB-based fiscal rules issues Challenges/requirements: –Reliable fiscal statistics: valuation base, classifications, timeliness –Selectivity in adjusted components, elasticities, independent variables –Well known, validated methodology –Trust in assumptions –Access to liquidity

Requisites for a successful SBFR Methodological Fiscal Macro-financial Political

Questions 1.Does the economic authority (MoF, CB) regularly estimate structural (cyclically-adjusted) fiscal balances? 2.Are you aware of SB estimates available for your country? 3.Use of SB: internal monitoring, public, presented with budget? 4.Problems encountered estimating SB 5.Does your country apply a fiscal rule? 6.Have you considered applying a SB-fiscal rule? 7.If yes, what are the expected uses of the fiscal rule? 8.If not, why have you discarded such rule?