Fiscal rules, inertia and discretionary fiscal policy

Abstract

In current practice, changes in the cyclically-adjusted budget balance (CAB) are generally interpreted as reflecting the effort of discretionary fiscal policy. This paper shows that such an interpretation is not a sufficiently accurate description of the behaviour of fiscal policy, and, in some cases, it may even conceal an important deficit bias. Specifically, as growth projections are an important building block of budgetary plans, optimism in forecasting growth, coupled with pervasive lags and inertia in the implementation phase of the budget, will result in a fiscal expansion, even in the absence of discretionary measures.fiscal policy, cyclically-adjusted budget balance, potential output, forecast accuracy, policy inaction, Larch, Salto