Thursday 11 March 2010

Automatic Stabilizers and the Deficit

   In the previous post Pedro Pita Barros asks how much of the current deficit is due to “automatic stabilizers” and therefore how much of the recovery will be automatic as well. For a quick answer one has to look at measures of the cyclically-adjusted deficit and this what I do here.    The cyclically-adjusted deficit is computed (in this case by the OECD) to show the underlying fiscal position when cyclical or automatic movements are removed. The cyclically adjusted components are calculated from actual tax revenues and expenditures adjusted using the ratio of potential output to actual output, the ratio between structural unemployment and actual unemployment and the assumed elasticities. OECD use several indicators to capture the degree of resource utilization and compute measures of potential output and unemployment. These calculations constitute an approximation and are of course subject to errors. The overall cyclical sensitivity of the budget to the economic cycle can be calculated by the semi-elasticity of the budget balance with respect to the output gap. This semi-elasticity is 0.46 for Portugal, meaning that for each percentage point change in GDP the budget balance change, as a per cent of GDP by 0.46. Estimates of real GDP growth are around -3%. That would imply that circa 1.5% of the primary deficit GDP ratio is due to the GDP contraction.This number looks small and I suspect that a larger fraction of the deficit-gdp ratio is due to the crisis. Why should I not trust the semi-elasticity estimate? This leads me to the more general question in the next post.

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