- Volker Treichel, and Ahsan Mansur
- Published Date:
- November 1999
Fiscal impulse analysis is a tool used to identify expansionary and contractionary periods of fiscal policy by comparing the actual deficit with a hypothetical deficit that would have materialized if fiscal policy had been neutral.1 The hypothetical deficit is calculated based on the assumption that expenditure is unit-elastic with respect to the potential growth rate of nominal GDP, whereas revenue is unit-elastic with respect to the actual growth rate of nominal GDP.
To calculate the stance of fiscal policy in a given year, the cyclically neutral deficit (Bn) is calculated by subtracting, from the base-year ratio of revenue to GDP multiplied by actual nominal GDP in the current year, the base-year ratio of expenditure to GDP multiplied by potential GDP in the current year:
T = government revenue,
G = government expenditure,
to = To/Yo the revenue ratio in the base year,
go = Go/Yo a base-year expenditure ratio,
Y= actual output in nominal prices,
Yp = potential output in nominal prices.
The actual deficit in a given year can be described as either expansionary or contractionary, depending on whether it exceeds or falls short of, respectively, the cyclically neutral budget B. The fiscal stance is defined as the difference between the cyclically neutral budget deficit B” and the actual deficit B:
where fis is the fiscal stance. The first difference of fis then describes the nature of the fiscal impulse.
Another useful tool for analyzing the fiscal stance is the structural budget deficit. Conceptually, the structural deficit is the deficit that would have materialized if the economy were moving along its normal trend, that is, in neither a recession nor a boom. An appropriate choice of the base year is critically important for measuring the structural balance correctly. The structural deficit (Bs) is calculated by subtracting the fiscal stance (fis) from the base-year deficit:
If the stance of fiscal policy is expansionary (fis < 0), and the budget was in deficit in the base year (Bo < 0), the structural balance will be higher than the base-year balance.
The calculation of Bn requires the calculation of the growth rate of potential output and the selection of a base year. There are different methods for calculating the growth rate of potential output.2 In this paper the potential output growth rate for Oman has been defined as the average growth rate over the period 1981–97. The basic criterion for choosing a base year is that potential and actual output should not have diverged substantially in that year. Moreover, given the importance of the oil price for Oman’s economy, the base year should not be one in which oil prices were extremely high or low.
Based on these two criteria, over the period 1981–97 two base years have been identified: 1983 and 1991. The year 1983 is the benchmark for assessing fiscal performance during 1981–86, prior to the collapse of the oil price, and 1991 is the base year for the subsequent period 1987–97. In those two years potential output exhibited a relatively small deviation from actual output. Also, in those years the oil price was close to the average over the period in question.3 In calculating the structural deficit, the same two base years (1983 and 1991) were assumed as in the calculation of the cyclically neutral budget.
For a comprehensive review of fiscal impulse analysis, see Heller, Haas, and Mansur (1986).
See Heller, Haas, and Mansur (1986) for a review of different methodologies for defining potential output.
Using the two criteria in rigid fashion would have led to the choice of 1992 as the base year for the second period, because the deviation of potential from actual output was the smallest in that year, and the oil price was close to the average over 1987–95. The reason for not selecting 1992 as the base year is that in that year expenditure was very high, primarily because, in the aftermath of the Gulf war, defense expenditure reached a very high level. Under these circumstances, the choice of 1992 as a base year would have led to the conclusion that, in other years, fiscal policy was contractionary. The considerations for not choosing 1992 highlight the fact that judgment needs to be applied in identifying a suitable base year for fiscal impulse analysis.
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