Identifying Fiscal Policy Transmission in Stochastic Debt Forecasts

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. 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.

Public debt dynamics: the effects of austerity, inflation, and growth shocks

“…Celasun, Debrun, and Ostry (2007) simulated debt paths for emerging countries based on combining an estimated fiscal reaction function from a panel regression and country-specific VARs of other macroeconomic variables without debt feedback. 12 Focusing on debt forecasts, Kawakami and Romeu (2011) apply the VAR with debt feedback to the Brazilian data. Many others use cross-country data to study the link between the level of debt and macroeconomic variables such as growth (e.g.…”

How Do Financial Institutions Forecast Sovereign Spreads?

“…This choice is also supported by a Hausman test.12 There may of course be an independent effect of the instruments on the year-ahead spread as forecasters make a consistent forecast over time, by which the next year forecast probably depends on the macroeconomic forecasts of this year(Kawakami and Romeu, 2011).i  ECB Working Paper 1750, December 2014…”

Safe Debt and Uncertainty in Emerging Markets: An Application to South Africa

“…To factor in the impact of uncertainty on debt, a number of studies have moved toward a "fan-chart" approach to debt forecasting (see e.g., Celasun et al, 2006;Kawakami and Romeu, 2011;and Burger et al, 2011). In this methodology, which also forms part of the IMF's revised public debt sustainability analysis (IMF, 2013b), a country-specific Vector Auto-Regression (VAR) comprising the non-fiscal determinants of public debt dynamics is estimated on historical data.…”