Official Optimism

Governments consistently overestimate their future budgets:

Analyzing data for 33 countries, Frankel finds that the average upward bias in the official forecast of the budget balance, relative to the realized balance, is 0.2 percent of GDP at the one-year horizon, 0.8 percent at the two-year horizon, and 1.5 percent at the three-year horizon. The longer the horizon, and the more genuine uncertainty there is, the more scope there is for wishful thinking. The bias is not larger for the commodity producers, … or for the developing countries, than for others. …

Over-optimism in predicting growth appears linked to over-optimism in predicting budget balances. On average, the upward bias in growth forecasts is 0.4 percent when looking one year ahead, 1.1 percent at the two-year horizon, and 1.8 percent at three years. The bias in growth forecasting appears in the United States and most other industrialized countries, but not among the commodity producing countries in the sample. …

Over-optimism is more prominent, for both budget balances and for economic growth, during economic booms. …. Countries subject to a budget rule … make official forecasts of growth and budget deficits that are even more biased and more correlated with booms than do other countries. Evidently when such governments exceed the deficit limits set by the rules, they respond by adjusting their forecasts rather than by adjusting their policies …

As a result of budget institutions created in 2000, Chile’s official forecasts of growth and of budget balance have not been overly optimistic, even in booms. (more)

The key institutional innovation [in Chile] is that there are two panels of experts whose job it is each mid-year to make the judgments, respectively, what is the output gap and what is the medium term equilibrium price of copper, rather than leaving the job to government officials. …. A reinforcement of the Chilean idea would be to give the panels legal independence. There could be laws protecting them from being fired, as there are for governors of independent central banks. (more)

Prediction markets forecasting budget balances and growth rates would be easy, and they’d reliably resist political pressure for overly optimistic estimates. So why even bother with trying to figure out how to design expert panels that can remain both expert and independent? Either Frankel naively thinks this easy, he is ignorant of the market solution, or doesn’t really want to promote accurate budget estimates.

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  • http://www.ciphergoth.org/ Paul Crowley

    Overall I favour your proposal, but I would have thought prediction markets would show a slight *downward* bias because they provide a way for investors to hedge against disappointing growth numbers.

  • Eric Falkenstein

    Here’s an economist who got fined for saying the Argentine inflation rate is above government measures…I don’t think people want the truth, especially large organizations (governments, industry groups, etc).

  • http://www.uweb.ucsb.edu/~criedel/ Jess Riedel

    “A pundit has endorsed a solution which differs from my preferred solution. He is either stupid, ignorant, or dishonest”. This type of rhetoric can’t possibly be intellectually healthy. Why not just present your preferred solution and argue for it being better?

    • Wonks Anonymous

      Agreed.

      I find it plausible he doesn’t know about prediction markets. Isn’t that kind of a niche topic?

      • http://goodmorningeconomics.wordpress.com jsalvatier

        Yup.

      • Hansenista

        I’m pretty sure that’s what Robin meant by saying Frankel might be “ignorant of the market solution”, even though a phrase like that usually means something much stronger.

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  • Douglas Knight

    To elaborate on Robin’s complaint, lots of countries claim to have independent experts. Frankel even points out the CBO in the US, though the example he gives of political manipulation of it is not relevant to short-term forecasts. It is not useful to find the country achieving the best results and copy its description of its institutions; one must compare it to other countries

    open

  • Unnamed

    Did the paper also see how forecasts compare to the median actual growth rate (rather than the mean)? In other words, what percent of the time does the actual growth exceed the forecasted growth and what percent of the time does it fall short?

    The distribution of growth rates is skewed (growth much slower than average is more common than growth much faster than average), which means that the median growth rate is larger than the mean growth rate. So if projections were aiming for the 50th percentile, rather than the mean, they would tend to overestimate growth by the measures used in this passage.

  • Doc Merlin

    You are missing the point. It isn’t a bug its a feature.
    They are trying to lie so they can inflate their budget projections without looking as bad. They could do accurate budget forecasts but often the law explicitly prevents them from doing so.

  • Eliezer Yudkowsky

    I think you’re coming on too strong in the final paragraph. Frankel could easily reply thusly: “Empirically, they did it in Chile, and it worked. I’m just recommending what has been observed to work – your arguments that prediction markets should work and should resist manipulation are interesting, but you cannot criticize me for recommending an empirically tested, actually-working solution over a theoretical one.” Even I tend to be sympathetic to that sort of argument when it is an actually-observed-adequate solution that is being defended, rather than, as usual, inaction or an inadequate solution.

  • http://entitledtoanopinion.wordpress.com TGGP

    Unnamed and Eliezer both make good points. “Why even bother” isn’t even that good of a question, since imitating successful countries is more likely than the government starting such a market. Maybe not for good reasons, but Frankel can’t be blamed for that.

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