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© 2024 International Monetary Fund
WP/24/251
IMF Working Paper
Strategy, Policy and Review Department
Output Gap Uncertainty and Fiscal Policy Adjustment in Real-Time in Emerging Economies
Prepared by Giacomo Cattelan and Boaz Nandwa *
Authorized for distribution by Anna Ilyina
December 2024
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: Uncertainty around the real-time output gap has important implications for fiscal policy. This study uses successive vintages of the World Economic Outlook for emerging markets (EMs) during 1998–2022 to examine the reaction of discretionary fiscal policy to uncertain economic cycle in real-time. The findings show that EMs tend to have persistently negative and significantly more volatile real-time output gap estimates compared to advanced economies (AEs) and are less responsive to the output gap shocks. We calibrate a New Keynesian DSGE model to match the behavior of an average EM. The results from the model suggest that when EM policy makers are equally concerned about uncertainty around the output gap estimates and about fiscal implementation, fiscal policy is less counter-cyclical than the benchmark case with no uncertainty, entailing an efficiency loss for the purpose of output gap stabilization. On the other hand, when the concern is only about output gap uncertainty, EM policy makers tend to react more counter-cyclically but at a cost of public debt spiking in the short term and stabilizing over the long term. This implies that it might be optimal for EM policy makers to act more aggressively to stabilize the economy. We show that by adjusting the relative importance of output gap vs debt stabilization in their objective function, EM policy makers can achieve a similar outcome as in the benchmark case with no uncertainty.
| JEL Classification Numbers: | C3, D8, E1, E6, H3, H6 |
| Keywords: | Fiscal policy; real-time output gap estimates; public debt |
| Author’s E-Mail Address: | gc2507@nyu.edu, bnandwa@imf.org |
| JEL Classification Numbers: | C3, D8, E1, E6, H3, H6 |
| Keywords: | Fiscal policy; real-time output gap estimates; public debt |
| Author’s E-Mail Address: | gc2507@nyu.edu, bnandwa@imf.org |
Contents
1 Overview
2 Stylized Facts
2.1 Data and Methodology
2.2 Summary Statistics
2.2.1 Output Gap
2.2.2 Cyclically Adjusted Primary Balance
2.3 Real-time Fiscal Reaction Functions
2.3.1 Methodology
2.3.2 Instrumental variables
2.3.3 Results
3 Model
3.1 Households
3.2 Firms
3.2.1 Final Good Producer
3.2.2 Intermediate Goods Producers
3.3 Government
3.4 Equilibrium
3.5 Log-linear economy
3.6 Benchmark Optimal Fiscal Policy
3.7 Optimal Fiscal Policy under Uncertainty
3.8 Calibration and Simulation
4 Conclusions
References
Appendix
Fiscal Reaction Function Robustness Checks
Model Solution
Household Problem
Final Good Producer
Intermediate Goods Producers
Equilibrium
Log-linearization
Benchmark problem
This study was completed while Giacomo was a summer intern at the IMF. We would like to thank SPR seminar participants, Tannous Kass-Hanna, Hideaki Matsuoka, and Francis Vitek for valuable comments. The usual caveats apply.