Over-optimistic Official Forecasts in the Eurozone and Fiscal Rules

Jeffrey A. Frankel, Jesse Schreger

NBER Working Paper No. 18283
Issued in August 2012
NBER Program(s):Economic Fluctuations and Growth, Public Economics

Why do countries find it so hard to get their budget deficits under control? Systematic patterns in the errors that official budget agencies make in their forecasts may play an important role. Although many observers have suggested that fiscal discipline can be restored via fiscal rules such as a legal cap on the budget deficit, forecasting bias can defeat such rules. The members of the eurozone are supposedly constrained by the fiscal caps of the Stability and Growth Pact. Yet ever since the birth of the euro in 1999, members have postponed painful adjustment by making overly optimistic forecasts of future growth and budget positions and arguing that the deficits will fall below the cap within a year or two. 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 what is the record with such national rules?

Our econometric findings are summarized as follows:

• Governments' budget forecasts are biased in the optimistic direction, especially among the Eurozone countries, especially when they have large contemporaneous budget deficits, and especially during booms.

• Governments' real GDP forecasts are similarly over-optimistic during booms.

• Despite the well-known tendency of eurozone members to exceed the 3% cap on budget deficits, often in consecutive years, they almost never forecast that they will violate the cap in the coming years. This is the source of the extra bias among eurozone forecasts. If euro area governments are not in violation of the 3% cap at the time forecasts are made, forecasts are no more biased than other countries.

• Although euro members without national budget balance rules have a larger over-optimism bias than non-member countries, national fiscal rules help counteract the wishful thinking that seems to come with euro membership. The reason is that when governments are in violation of the 3% cap the national rules apparently constrain them from making such unrealistic forecasts.

• Similarly, the existence of an independent fiscal institution producing budget forecasts at the national level reduces the over-optimism bias of forecasts made when the countries are in violation of the 3% cap.

download in pdf format
   (1559 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w18283

Published: Review of World Economics June 2013, Volume 149, Issue 2, pp 247-272 Date: 14 Feb 2013 Over-optimistic official forecasts and fiscal rules in the eurozone Jeffrey Frankel, Jesse Schreger

Users who downloaded this paper also downloaded* these:
Bordo, Markiewicz, and Jonung w17380 A Fiscal Union for the Euro: Some Lessons from History
Wyplosz w17884 Fiscal Rules: Theoretical Issues and Historical Experiences
Buiter and Patel w15934 Fiscal Rules in India: Are They Effective?
Frankel w17239 Over-optimism in Forecasts by Official Budget Agencies and Its Implications
Gordon w18315 Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us