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Working Paper

298.
Modelling and Forecasting Fiscal Variables for the Euro Area

by Carlo A. Favero and Massimiliano Marcellino

Abstract

In this paper we assess the possibility of producing unbiased forecasts for fiscal variables in the
euro area by comparing a set of procedures that rely on different information sets and
econometric techniques. In particular, we consider ARMA models, VARs, small scale semi-
structural models at the national and euro area level, institutional forecasts (OECD), and
pooling. Our small scale models are characterized by the joint modelling of fiscal and monetary
policy using simple rules, combined with equations for the evolution of all the relevant
fundamentals for the Maastricht Treaty and the Stability and Growth Pact. We rank models on
the basis of their forecasting performance using the mean square and mean absolute error
criteria at different horizons. Overall, simple time series methods and pooling work well and are
able to deliver unbiased forecasts, or slightly upward biased forecast for the debt-GDP
dynamics. This result is mostly due to the short sample available, the robustness of simple
methods to structural breaks, and to the difficulty of modelling the joint behaviour of several
variables in a period of substantial institutional and economic changes. A bootstrap experiment
highlights that, even when the data are generated using the estimated small scale multi
country model, simple time series models can produce more accurate forecasts, due to
their parsimonious specification. 

JEL Classification: C53, C30, E62

Keywords: Fiscal forecasting, Forecasting comparison, Fiscal rules, Euro area

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Last updated February 27, 2007