Identifying Fiscal Policy Transmission in Stochastic Debt Forecasts

36 Pages Posted: 20 May 2011

See all articles by Kei Kawakami

Kei Kawakami

affiliation not provided to SSRN

Rafael Romeu

International Monetary Fund (IMF)

Date Written: May 2011

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.

Suggested Citation

Kawakami, Kei and Romeu, Rafael, Identifying Fiscal Policy Transmission in Stochastic Debt Forecasts (May 2011). IMF Working Paper No. 11/107, Available at SSRN: https://ssrn.com/abstract=1847340

Kei Kawakami (Contact Author)

affiliation not provided to SSRN

Rafael Romeu

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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