PREDICTIONS OF PRIMARY BALANCE IN 2011 AND 2012 BASED ON THE FRF

The estimated primary balance ratios can be used to formulate out of sample predictions for the primary balance for the years 2011 and 2012. These can be compared with the most recent primary balance forecasts available in AMECO.(125)

Predictions are calculated as fitted primary balance values based on estimated FRF coefficients in the longer benchmark regression and on existing Commission forecasts for 2011 and 2012 for all explanatory variables.(126) Graph IV.4.1 displays the model's predictions for the primary balance 2011 on the upper chart and for 2012 on the lower chart, against corresponding Commission forecasts.

The results indicate that the existing European Commission forecasts may be biased upward for 2011 and, to a lesser extent, 2012 compared to Member States' historical surplus-generating capacity. FRF predictions for the primary balances of twenty-five and twenty-two Member States are worse than the Commission forecasts in 2011 and 2012, respectively, although the magnitude of the gap varies by country. Exceptions to this pattern are HU and LV in 2011 and EE, EL, HU, IE and LV in 2012. This is to some extent unsurprising, as in the current (quite exceptional) circumstances many countries have introduced sizeable consolidation measures in order to counteract the effect of the economic downturn on fiscal balances and such measures may have lasting implications on their public finances over next years.

(125) The Commission's Autumn 2010 forecasts are used here. (126_{) 2011 and 2012 updates of the electoral dummy (i.e.}

legelec) are based on information available in the European Election Database constructed as part of the European Sixth Framework Research Programme "Citizens and Governance in a Knowledge-based Society" (CivicActive),

http://www.nsd.uib.no/european_election_databa se/. As for the variable on government majority in parliament (maj), values for 2011 or for both 2011 and 2012 have been set equal to the one in 2010 whenever no elections occurred/are scheduled in these years. If an election took place/is scheduled in 2010/2011 then maj for the following year(s) is set at a value equal to the country average of maj over the sample period (in the absence of better information).

Part IV Debt sustainability in the EU

Graph IV.4.1: Primary balance forecast vs. (point) prediction from FRF model 2011 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 AT BE BG CY CZ DE DK ES EE FI FR UK EL HU IE IT LT LU LV MT NL PL PT RO SK SI SE pbal_model prediction pbal_commission forecast 2012 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 AT BE BG CY CZ DE DK ES EE FI FR UK EL HU IE IT LT LU LV MT NL PL PT RO SK SI SE pbal_model prediction pbal_commission forecast

Notes: One figure for Ireland in 2011 is below the minimum number shown in the axis.

Source: Commission services calculations based on AMECO and World Bank Database of Political Institutions.

To compare the two figures more appropriately, one standard deviation of the FRF estimated regression is added and subtracted to the (point) estimates of primary balance in 2011 and 2012.(127)

Graph IV.4.2 plots existing forecasts against those ranges represented by a minimum and maximum predicted primary balance per country.

(127_{) This implicitly assumes that the width of the range is the}

same for all Member States, i.e. the predicted value for primary balance +/- 1.83, which is the value of the regression's standard deviation.

Graph IV.4.2: Primary balance forecast vs. min and max prediction from FRF 2012 -10 -8 -6 -4 -2 0 2 4 AT BE BG CY CZ DE DK ES EE FI FR UK EL HU IE IT LT LU LV M NL PL PT R SK SI SE pbal_model prediction_min pbal_model prediction_max pbal_commission forecast 2011 -10 -8 -6 -4 -2 0 2 4 AT BE BG CY CZ DE DK ES EE FI FR UK EL HU IE IT LT LU LV M NL PL PT R SK SI SE pbal_model prediction_min pbal_model prediction_max pbal_commission forecast

Notes: The figures for Ireland in 2011 are below the minimum number shown in the axis.

Source: Commission services calculations based on AMECO and World Bank Database of Political Institutions.

In 2011, existing forecasts lie outside the range predicted by the fiscal reaction function for a majority of EU Member States, i.e. sixteen out of twenty-seven, with fifteen of them posting a forecast which exceeds the maximum predicted value; whereas only LV forecasts a primary balance which is worse than the minimum prediction. On the other hand, forecasts lie within the predicted ranges for most Member States in 2012. There are only five exceptions to this pattern; DE, IT, LU and SE post forecasts exceeding the maximum predicted primary balance while LV has a forecast balance worse than the minimum prediction. It should be noticed that the predicted ranges of primary balance values are quite large, with a difference of about 3.6 pp of GDP between the lower and upper end, indicating a rather imprecise estimate.

An alternative approach which allows for the predictions' ranges to vary by country is to add to (subtract from) point estimates for 2011 and 2012 the average of the three best (worst) shocks to the primary balance over the sample period, as

European Commission Public finances in EMU - 2011

172

measured by the three highest (lowest) residuals of the FRF regression. This would provide a measure of the uncertainty of predictions reflecting the country specificities more closely. Graph IV.4.3 plots those ranges against existing primary balance forecasts.

Graph IV.4.3: Primary balance forecast vs. predictions from FRF +/- average of three best/worst primary balance shocks 2012 -14 -12 -10 -8 -6 -4 -2 0 2 4 AT BE BG CY CZ DE DK ES EE FI FR UK EL HU IE IT LT LU LV MT NL PL PT RO SK SI SE pbal_model prediction_worst pbal_model prediction_best pbal_commission forecast 2011 -12 -10 -8 -6 -4 -2 0 2 4 AT BE BG CY CZ DE DK ES EE FI FR UK EL HU IE IT LT LU LV MT NL PL PT RO SK SI SE pbal_model prediction_worst pbal_model prediction_best pbal_commission forecast 201

Notes: The figures for Ireland in 2011 are below the minimum number shown in the axis.

Source: Commission services calculations based on AMECO and World Bank Database of Political Institutions.

As with Graph IV.4.2, the ranges of the predicted primary balance values tend to be quite sizeable, albeit with large variation by country. Contrary to the upper chart of Graph IV.4.2 the primary balance forecasts now tend to also lie within predicted ranges in 2011, although eight Member States still exceed the best prediction. As the upper chart of Graph IV.4.3 shows, Latvia still posts a forecast lower than the worst prediction. In 2012 the primary balance forecasts lie outside predicted ranges only in the cases of IT and SI where they exceed the best prediction.