Pro-cyclical Fiscal Policy and Over-optimism in Official Forecasts

The cyclical behavior of Fiscal policy differs across income groups. In the past, while industrial countries have tended to pursue Fiscal policy that is countercyclical or at worst acyclical, developing countries have tended to follow procyclical behvior: they have increased spending (or cut taxes) during periods of expansion and cut spending (or raised taxes) during periods of recession. Many authors have documented that fiscal policy has tended to be more procyclical in developing countries, in comparison with industrialized countries. However, this paper argues that over the last decade several developing countries have been able to “graduate” the sense of overcoming the problem of procyclicality and becoming countercyclical. The author will also present his findings related to policy implications and quality of forecasts of real growth rates and budget balances made by some official government agencies. The author studies the possibility that forecasts of fiscal revenues are overly optimistic, those forecasting biases are amplified during periods of expansion and also the role of budget rules in addressing this issue.