The Forecasting Capacity of Indicators Measuring Budget Sustainability

Abstract

Since the outbreak of the European debt crisis, fiscal sustainability as a research area became more and more popular. This paper aims to assess the predicting power of the basic types of the following five fiscal sustainability indicators: primary gap (1), stationary tests for public debt (2), stationary test for the first differential of public debt (3), public revenues and expenditures cointegration (4); fiscal reaction function (5). The results indicate that predictive power is rather low for all indicators except for the first one. One reason for this may be that these indicators ignore the factors outside the range of fiscal policy. After comparing our result with previous research studies, we conclude that the results of these tests are heavily influenced by the choice of parameters, samples and the econometric methods used. For these reasons, it appears reasonable to evaluate and compare the predictive power of all fiscal sustainability indicators. By utilising the lessons learned, certain procedures should be standardised on the one hand, where this is possible, and on the other, methodology should be developed further in order to increase effectiveness.