Review of World Economics

, Volume 149, Issue 2, pp 247–272 | Cite as

Over-optimistic official forecasts and fiscal rules in the eurozone

Original Paper

Abstract

Eurozone members are supposedly constrained by the fiscal caps of the Stability and Growth Pact. Yet ever since the birth of the euro, members have postponed painful adjustment. Wishful thinking has played an important role in this failure. We find that governments’ forecasts are biased in the optimistic direction, especially during booms. Eurozone governments are especially over-optimistic when the budget deficit is over the 3 % of GDP ceiling at the time the forecasts are made. Those exceeding this cap systematically but falsely forecast a rapid future improvement. The new fiscal compact among the euro countries is supposed to make budget rules more binding by putting them into laws and constitutions at the national level. But biased forecasts can defeat budget rules. What is the record in Europe with national rules? The bias is less among eurozone countries that have adopted certain rules at the national level, particularly creating an independent fiscal institution that provides independent forecasts.

Keywords

Budget Discipline Euro Europe Eurozone Fiscal Fiscal compact Forecast Independent Institutions Maastricht criteria Optimism Procyclical Rule Stability and Growth Pact Wishful thinking 

JEL Classification

E62 H50 

Supplementary material

10290_2013_150_MOESM1_ESM.doc (262 kb)
Supplementary material 1 (DOC 262 kb)

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Copyright information

© Kiel Institute 2013

Authors and Affiliations

  1. 1.Harvard UniversityCambridgeUSA

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