Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/196122
Authors: 
Larch, Martin
Cugnasca, Alessandro
Kumps, Diederik
Orseau, Eloïse
Year of Publication: 
2019
Series/Report no.: 
ZEW Discussion Papers 19-013
Abstract: 
Fiscal policymakers are expected to conduct countercyclical policies to mitigate cyclical fluctuations of output, but the assessment of cyclical conditions in real time is subject to considerable uncertainty. They face two types of risk: (i) launching discretionary measures to support or dampen aggregate demand when no measures are required (type I error), or (ii) not launching any stabilising measures when this is warranted by cyclical conditions (type II error). A rational policymaker could manage these risks by correcting real-time estimates for past errors, notably the apparent tendency to underestimate good times when they occur. In practice, however, fiscal policy has been largely pro-cyclical or a-cyclical at best. Using statistical decision theory, we calculate thresholds for realtime output gap estimates beyond which governments could launch stabilisation measures, so as to reduce the risk of running pro-cyclical policies. We consider different preferences for avoiding type I or type II errors, and for addressing upside and downside growth risks. We show that the tendency to run pro-cyclical fiscal policy and the ensuing deficit bias can reflect two factors: a preference for activism that is, attaching a lower cost to type I errors, combined with an inclination to be gloomy about cyclical conditions.
Subjects: 
fiscal stabilisation
pro-cyclical fiscal policy
risk management
real-time output gap estimates
JEL: 
E62
E63
H68
Document Type: 
Working Paper
Social Media Mentions:

Files in This Item:
File
Size
439.67 kB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.