Fiscal fan charts - A tool for assessing member states’ (likely?) compliance with EU fiscal rules

This paper sets out a methodology for constructing fan charts for the government deficit and debt ratios over the medium-term. It relies on information contained in Stability/Convergence Programme Updates, a model of the relevant stochastic process (for example, the real GDP process) or processes, and a parameter estimate of the sensitivity of the primary budget balance to the output gap for the member state under consideration. A model of the dynamic deficit-debt relationship allows the impact of random output growth to work its way through the fiscal arithmetic in a consistent and traceable way to produce fan charts over a five-year forecast horizon. The initial set of fiscal fan charts included here for Ireland use the indicative public finance projections set out in the 2011 Update for Ireland. The range of possible fiscal outcomes in the charts assumes no fiscal policy response to any change in the budgetary position over the period such as could arise from changes in growth rates. This assumption of “no policy change” is a standard one in the construction of fan charts. Governments will, however, generally be in a position to adjust fiscal policy towards meeting a specific fiscal target, such as reaching a deficit position of less than 3 percent of GDP in the medium-term. A second set of fan charts is included which indicates how the probabilistic range of fiscal outcomes could be affected by a tightening of fiscal policy in 2013-2015.