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IFDP
NUMBER

274

273

272

271

270

269

268

267

266

265

264

International Finance Discussion Papers

TITLES

1986
International Comparisons of Fiscal Policy:
The OECD and the IMF Measures of Fiscal
Impulse

An Analysis of the Welfare Implications of
Alternative Exchange Rate Regimes: An
Intertemporal Model with an Application

1985
Expected Fiscal Policy and the Recession
of 1982

Elections and Macroeconomic Policy Cycles

Assertion Without Empirical Basis: An
Econometric Appraisal of Monetary Trends
in... the United Kingdom by Milton Friedman
and Anna J. Schwartz

Canadian Financial Markets:
Proposal for Reform

The Government's

Was It Real? The Exchange Rate Interest
Differential Relation, 1973-1984

The U.K. Sector of the Federal Reserve's
Multicountry Model: The Effects of
Monetary and Fiscal Policies

Optimal Currency Basket in a World of
Generalized Floating: An Application to
the Nordic Countries

Money Demand in Open Economies:
Substitution Model for Venezuela

A Currency

Comparing Costs of Note Issuance Facilities
and Eurocredits

AUTHOR( s)

Garry Schinasi

Andrew Feltenstein
David Lebow
Anne Sibert,

William H. Branson
Arminio Fraga
Robert A. Johnson

Kenneth Rogoff
Anne Sibert:

David F. Hendry
Neil R. Ericsson

Garry J. Sehinasi
Richard Meese
Kenneth Rogoff

Hali J. Edison

Hali J. Edison
Erling Vardal

Jaime Marquez

Rodney H. Mills

Please address requests for copies to International Finance Discussion
Papers, Division of International Finance, Stop 24, Board of Governors of

the Federal Reserve Board, Washington, D.C.

20551.


-9-

III. Ar Analytical Comparison of the Two Measure

Comparable Treatment of Unemployment Insurance Benefits

The derived adjusted budget balances described in the previous
sectior. (eq.(3) and eq.(6)) treat unemployment insurance benefits
differently. In estimating cyclical expenditures, the OECD treats these
benefits like other government expenditures. The IMF, on the other hand,
removes UIB from its calculation of the adjusted balance by excluding it
from the actual budget (B*) and its policy parameter (g*). The IMF measure

can be adjusted. Since

wo
fy

Bet UIB,

and sirce

oR
fo)
fy

(G- UIBL)/Y,
we can rewrite the adjusted budget balance as

F P * P
(7) AB, = By (toy, BY.) + ULB, (By 8) Yeo

where E is comparable to the budget concept used by OECD, g, is the ratio
of total government expenditure to GDP in the base period, and Bo-B3=
(UIBp/Y¥9) and represents the unemployment insurance benefit payout ratio in

the base period, which will be labelled p in subsequent discussion.


-15-
some patterns emerge, they are less obvious. For the United States, fiscal
drag again plays a minor role in explaining the overall discrepancy between
fiscal impulse measures. The other three categories explain major or minor
shares depending on which year is examined; in 1982, a recession year, all
three categories show that the OECD and IMF measures diverged widely. For
Japan, no clear pattern emerges except that cyclical revenue adjustments
accounted for a consistently large share of the total discrepancy in fiscal
impulse measures for Japan. Finally, for Canada no clear pattern emer ges

at all.

Isolating Differences in Adjusted Balances and Fiscal Impulse

Although eq. (13) is a useful decomposition of the discrepancy in
fiscal impulse measures, one can easily think of other decompositions. For
example, answers to the following question would be useful: What part of
the overall discrepancy is traceable to differences in Parameter estimates,
differences in estimates of potential GDP, or differences in methodologies?
Unfortunately, parametric differences are difficult to interpret and
methodological differences are difficult to quantify.

Parametric Differences:

Differences in the two measures arising from differences in
parameter estimates are difficult to interpret. The OECD parameters for
time period t are estimated marginal rates derived from estimated short-run
income-elasticities of revenue and expenditure and actual revenue and
expenciiture shares in time period t. The IMF parameters are actual ratios

(average rates) of revenues to GDP and expenditures to potential GDP


-2-
output. Because the OECD and the IMF adjustments to actual budget balances
are different, the two measures are different numerically. But are these
differences significant? More importantly, are the measures comparable in
the sense that they try to measure similar magnitudes? This paper attempts
to answer these questions.

The paper is organized as follows. The first section presents
and briefly discusses fiscal impulse measures for the major industrial
countries published by both agencies in their most recent publications.

The second section describes the OECD and IMF methodologies. The third
section compares the two methods by adopting a rather conventional
decomposition of actual budget balances. The focus is on differences in
the levels of adjusted budget balances (what is often called the fiscal
stance), which more easily reveals differences in methodologies. The fourth
section numerically allocates discrepencies in adjusted balances (both
levels and ratios) and changes in adjusted balances (levels and ratios) to
potential sources such as differences in estimates of potential GNP. A

concluding section summarizes.

I. Estimates of Fiscal Impulse: the Nature of the Problem

Table 1 presents fiscal impulse measures published by the OECD
and the IMF for the major industrial countries over the period 1979-84.
These measures are defined as the negative of the change in the ratio of an

adjusted budget balance to potential GNP. The budget balance is defined as

2For a complete description of the OECD methodology see Muller and Price
and for a complete description of the IMF methodology see Heller, et al.


-21-
in levels (ratios). For the United States in particular, differences in
estimates of cyclical revenues and cyclical expenditures account for
consistently large shares of the total discrepancy in measures. For Japan
and Canada, fiscal drag explains a much larger share of the total
discrepancy, but cyclical revenues and expenditures also play a major role
at times. No other consistent patterns emerge for this particular scheme.

It was also possible to quantify the contribution to the tctal
discrepancy in fiscal impulse measures of differences in estimates of
potential GNP. It was found that a large ‘share of the discrepancy cén be
attributed to differences in potential GNP estimates, particularly fcr the
United States data.

Other differences, such as parameter differences, were not
sensibly quantifiable. The IMF assumes that tax receipts are unit elastic
with respect to actual GDP, while government expenditures (excluding
unemployment insurance benefits) are unit elastic with respect to potential
output. The OECD instead estimates short-run marginal tax and spending
rates. While comparing the OECD's mTM and m8 with the IMF's to and go
might be a useful exercise, it will not capture all of the discrepancy in
measures created by the different assumptions used to generate these
parameter estimates. Because of this difficulty, it was not possible to
quantify the effects of methodological differences (i.e., differences due
to factors other than parameter differences and differences in potential
GNP); but all other results point in the direction of concluding that. the

two measures are methodologically quite different.


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-17-
contribution to the overall discrepancy arising from the IMF using its own

estimate of potential, rather than the OECD's.

(14a) - gS(xF- yO)

Likewise, the following expression represents the contribution arising from

the OFCD using its estimate rather than the IMF's.!1

(14d) - (m? - m&)(yF - 0)

1lWe can also isolate the difference in adjusted budget balances arising from
methodological choices by controlling for all other factors. These factors
include parameter estimates and estimates of potential output. Assuming
parameter estimates and potential output estimates are identical leaves the
following expression:

r g P g P * P
(m -m)Y +m (¥Y -¥)- (UIB+g Y]
t t t t ot
P ie} F
where Y =Y =Y
t t t
r g&
and me=t;m -=+g.
° °

This expression demonstrates that the IMF excludes fiscal drag (the first
term) and that adjustments for cyclical expenditures are quite different
(the second and third terms). Note further that if the economy operates at
potential, then under these two assumptions the only difference is fiscal
drag:

r g Pp
(m -m)Y
t

The OECD perceives fiscal drag as part of the structure of fiscal policy
whereas the IMF does not. This difference in adjusted budget balances
remains regardless of the assumptions made.


- Wy -

first section of this paper, the direction of change of adjusted balances
(in levels and ratio form) is usually the same for both agencies; the
exception here is Canada for 1982. In general, the pattern of the
discrepancy in changes in levels of adjusted balances is similar to the
pattern that emerges in levels or ratios. For the United States, except: for
1979, most of the discrepancy in changes in levels is accounted for by
estimates of cyclical revenues and/or expenditures. Fiscal drag again
accounts for a relatively small fraction of the discrepancy in all years.
1979 was an unusual year in which estimates by each agency of the actual
change in the budget balance differed a great deal ("other"). And in 1982,
a year of deep recession, cyclical revenue and cyclical expenditure
adjustments differed a great deal, even though the overall discrepancy was
relatively small.

The data for Japan present a different picture. In most years,
fiscal drag consistently accounts for a large share of the discrepancy in
the change in levels, while cyclical expenditure adjustments account for a
relatively small share. In 1981 and 1982, the agencies' estimates of “she
change in the actual budget balances were quite different. Finally Canada
appears to be a hybrid case where each category of adjustment, except
"other", plays a major role in explaining the discrepancy in some years and
a minor role in other years. Fiscal drag, however, appears to account for
a consistently large share of the overall discrepancy.

The picture is somewhat different in table 6 where the
discrepancy in changes in the ratio of adjusted balances to GDP are

allocated among the various potential sources of differences. Although


- 22 -
References

Heller, Peter, S., Richard Haas, and Ahsan Mansur, "A Review of the Fiscal
Impulse Measure, with Estimates of the Structural Budget Balance." IMF
Department Memorandum, DM/85/18, March 21, 1985.

Muller, Patrice and Robert W.R. Price, "Structural Budget Deficits and
Fiscal Stance." OECD Working Paper #15, July 1984,

OECD Economic Outlook, OECD, December 1985.

World Economic Outlook, IMF, October 1985,


- 13 -

IV. An Examination of the Numbers

Sources of the Discrepancy in Adjusted Budget Balances?

Table 3 presents the level of the adjusted budget balances
implicit in the most recent OECD and IMF publications (December and October
1985, respectively) for the United States, Japan, and Canada. The table
allocates the discrepancy in the two measures according to equation (13).
(Note that table 4 reveals that the percent distribution of the total
discrepancy in the ratio of adjusted balances to GDP among potential
sources is similar to that of levels.) Referring back to table 3, note the
size of the discrepancies between the two measures and the large number of
discrepancies about whether the economy in question has a surplus or
deficit, particularly for Japan and Canada. For the United States large
discrepancies occur in the cyclical expenditure and cyclical revenue
adjustments while the fiscal drag adjustment (made by the IMF and not made
by the OECD) contributes very little to the discrepancy. In both Japan and
Canada, fiscal drag accounts for more than 100 percent of the discrepancy
in adjusted budget balances in all years except one (Canada 1983),
indicating the relatively large gap between tax and spending rates.

The more relevant comparisons are made in tables 5 and 6 which
present these same allocations for changes in adjusted balances and changes

in the ratio of adjusted balances to GDP, respectively. As stated in the

9source data for the calculations in this section were provided by the OECD
and the IMF. Calculated "fiscal impulse" measures may differ from the
measures actually published by the agencies due to rounding errors and
discrepancies created by using slightly updated source data.


-5-
policy-induced or discretionary component; and an income-induced component.
The adjusted balance measures that part of the budget balance which is
policy related or what has been called the "structural" deficit. It
includes the income-induced component which would exist were the economy
expanding along a trend growth path (potential, mid-cycle, or some other

path). These ideas can be made more rigorous as follows:
Q) Be = Boyt mY¢

where
BE = actual budget balance, defined as receipts (R) less expenditures (G)
Bpt # part of the budget independent of income (and in this
methodology discretionary)
Y~ = actual GDP
m 2 m® - m@ where m8, m& are the marginal rates of revenues and

expenditures, respectively, with regard to GDP.

The marginal tax and spending rates are derived from elasticities which are
estimated from structural models.

* Part of the income-induced component is unrelated to cyclical
changes in income. Actual output can be decomposed into "cyclical" and

“ "potential" as follows:

P P
yo + ors YX).


-19-

Each measure has methodological biases. Even if each agency used
the same parameters (which would move the methodologies closer to each
other), and the same measure of potential GNP, and even if the economy were
on its potential (or some other well defined) growth path, the two measures
would differ. This difference arises because the OECD perceives "fiscal
drag" as part of the structure of fiscal policy and therefore includes it
in its adjusted balance, whereas the IMF removes it.

In the IMF's methodology, a change in tax receipts creates an
impulse when revenues change as a share of actual GNP, while changes in
expenditures creates an impulse when expenditures change as a share of
potential GNP and when there is a change in the GNP gap. In other words,
the IMF perceives revenues which are more than proportional to actual GNP
(rather than potential GNP) as diminishing stimulus and it perceives
government expenditures (other than unemployment insurance benefits) which
are more than proportional to potential GNP as adding to stimulus. The
OECD, on the other hand, attempts to remove all "built-in" stabilizer

effects that result from deviations from potential output. In this sense,

the OECD's measure is more complete and consistent in cyclically adjusting
revenues and expenditures.

Which fiscal impulse measure is "best", however, clearly depends
on its uses. The "structural" approach used by OECD can answer some
relevant questions more accurately (but not necessarily as easily). The
IMF measure gives a bad answer to the question, "What would the budget
balance be along a trend path (possibly potential) of GNP?", and it gives a

bad answer to the question, "What part of the change in the actual budget


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334
revenues less expenditures, so a negative balance indicates a deficit.

When the fiscal impulse measure is positive it indicates a move towards
expansion (a larger deficit or smaller surplus), while if it is negative it
indicates a move towards restriction.

With the exception of Germany in 1981 and 1984 and Canada in 1982
both measures indicate the same direction of change of fiscal stimulus.
Magnitudes differ by amounts ranging between +.7 and 1.6 percentage points.

When fiscal impulse measures are translated into implicit levels
of the adjusted budget balances, differences between the two balances are
large relative to the actual budget balance. Table 2 presents actual
budget balances in local currencies. and implicit3 estimates of adjusted’
budget balances by the OECD and the: IMF. Column 4 presents absolute
differences between the two measures. As can be séén, these differences
can be quite large; with two exceptions, they range between +20-and°162~
percent of the actual balance.

In summary, there are substantial differences in implicit budget
adjustments. Are these differences merely the result of discrepancies: inTM»
estimates of potential (or actual) GDP, or are there substantial

differences in methodologies?

3These are calculated using source data provided by the OECD and the IMF.


Table 1!
Fiscal Impulse Measures

OECDe ImMF3 Difference

t

UOWEEI AWS LUW

United States 1979
1980
1981
1982 .
1983 .
1984 .

t

bobee
NO--=Nn

Japari 1979 >.
1980 -.
1981 >.
1982 -.

Cans

t
=r
on

WH-aANNY

1983
1984

b
=
t bee

AUAN SN

Germany 1 3n3 . i 9
1980 .
1981 +2 71.0
1982 =1.4 72.0
1983 “1.4 2.9
1984 7.5 +2

bros

France 1979 +29 71.
1980 +.3 +1.
1981 1.0 .

WONWAD WNHWEU

1982
1983 >
1984 1

United Kingdom 1979 >
1980 +1
1981 22.
1982 “1
1983 1

1984

Italy 1979 5
1980 3.9
1981 3.8
1982 >.6
1983 “1.7
1984 +2

Canada 1979 “1.
1980 :
1981 >.
1982 :
1983 1.
1984 1. .
7 A minus indicates a move in the direction of less stimulus ( a smaller
deficit).
2/ Change in the ratio of the structural budget balance to potential
GNP,as published in OECD Economic Outlook (Dec. 1985), multiplied by
minus one.
3/ Change in the ratio of fiscal stance to potential GNP multiplied by
minus one, as published in the World Economic Outlook.


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-4e

II. The OECD and IMF Adjustments to Actual Budget Balances

Generalities

This section describes the adjustments to actual budget balances
made by each agency and reproduces the equations that generate these
adjusted balances. Although fiscal impulse measures are defined as the
change in the adjusted budget balance (level or ratio), the focus of this
section is on the level of actual and adjusted budget balances4 to
clearly reveal methodological differences. However, neither agency places
any significance on these levels. For the purpose of cross-country
comparison, the adjusted budget balance is deflated by GDP. The fiscal
impulse is defined as the change in this ratio multiplied by minus one.
Fiscal impulse is a concept that represents the change in the impact of

budget balances.

The OECD's Method
The OECD's approach is to remove built-in-stabilizer effects from
the actual budget balance.5 To achieve this objective, the OECD assumes

the actual budget balance is composed of two major components: a

——-z——-—--

dhe level of the adjusted budget balance is what the OECD calls the fiscal
stance, whereas the IMF multiplies its adjusted balance by minus one to
derive its measure of fiscal stance.

5The OECD method is similar in spirit to the method used by the Bureau of
Economic Analysis. BEA's cyclically adjusted federal budget is constructed
according to the following procedure: (1) choose a reference trend for GNP
free of short-run fluctuations; (2) estimate response parameters
(elasticities) of components of revenues and expenditures to short-run
movements in GNP; (3) apply these responses to the gap between trend and
actual GNP to obtain "gross-ups"; and (4) add these "gross-ups" to the
actual budget to obtain a cyclically adjusted budget.


- 16 -
measured in the base year and implicitly assume that the tax elasticity
with respect to actual GNP and expenditure elasticity with respect to
potential GNP are unity. These parameters are presented in table 7.
Expenditure parameters differ significantly because of methodological
assumptions. Setting parameters equal is artificial because each set of
parameters is associated with methodological assumptions and their
differences are difficult to interpret and misleading. These computations
are therefore not presented.1!9

Differences in Potential GNP:

Contributions to the total discrepancy in the two measures
arising from different estimates of potential GNP can be calculated anc

interpreted unambiguously. The following expression represents the

10T9 estimate this contribution one can compare the discrepancy in adjusted
balances derived in eq.(13) to one derived under alternative parameter
assumptions. Two alternative assumptions are that both agencies use either
the OECD parameters or the IMF parameters. Setting the OECD parameters
equal to the IMF's is equivalent to assuming that the real world is
characterized by unit-elasticity of tax and spending rates so that OECD
estimates of marginal rates are identical to the IMF estimates of average
rates. Equations (a) and (b) below represent the contribution to the total
discrepancy of each agency using its own estimate rather than both ager.cies
using the same parameter estimates, either the OECD's or the IMF's,
respectively.

r * rt F
(a) ~(t -m )Y + (g-m )Y
° t °

r g °
(b) -((m- t )- (m- g )]l(¥-¥ )
° ° t t
Note that mr* is not a parameter estimated by the OECD, but it can safely be
assumed that it would be close to the IMF's estimate 88, These equations

represent the difference between the discrepancy in adjusted balances as
calculated by each agency and the discrepancy assuming each agency uses the

same parameters, either the OECD's as in eq(a) or the IMF's as in eq (bt).


International Finance Discussion Papers
Number 274

February 1986

INTERNATIONAL COMPARISONS OF FISCAL POLICY:
THE OECD AND THE IMF MEASURES OF FISCAL IMPULSE

by

Garry J. Schinasi

NOTE: International Finance Discussion Papers are preliminary materials
circulated to stimulate discussion and critical comment. References in
publications to International Finance Discussion Papers (other than an
acknow-.edgment by a writer that he has had access to unpublished
material) should be cleared with the author or authors.


-T-
would the budget balance be, given existing budgetary policies, were the
economy operating at full employment? The change in this adjusted balance
attempts to measure the policy-induced change in the budget, where the
budget impact of fiscal drag is presumed to be deliberate policy.
The IMF's Method

The IMF attempts to calculate the "initial impulse" to aggregate
demand from all fiscal sources (whether discretionary or otherwise) during
a given period. To achieve this objective, the IMF defines a "cyclically
neutral budget", which can be interpreted as an estimate of the cyclical

component of the budget. The cyclically neutral budget is defined as in

eq. (4).
4 t *yP
) CNB, = to YY, - ey
Ro
where ty > and Ry is total receipts in the base period,
°
» Gy UIB,
in se) and G, is total outlays in the base period,
°

and UIBp represents unemployment insurance benefits in the base period.

The IMF defines expenditure as cyclically neutral when changes in
expenditures from a base period are proportional to potential GNP. Since
the IMF views unemployment insurance benefits (UIB) as cyclically neutral,
it excludes UIB from expenditures and from the calculation of the
expenditure-policy parameter, gs. Revenues are cyclically neutral when
they change in proportion to actual GNP. These definitions imply tax

receipts are unit elastic with respect to actual GNP (marginal and average


-6-

yP is potential output and Y - YP is the output gap. The income-induced
component decomposes into a "fiscal drag" component and a
"puilt-in-stabilizer" component:

P

t

P
mY, = my, + mY, Y

The first term represents "fiscal drag" -- the budget balance at
"full-employment" resulting from the difference between tax and expenditure
rates (i.e. non-zero m). The second term represents built-in-stabilizer
effects or the balance resulting from eyelical fluctuations of the economy
along a trend growth path. Equation (1) now becomes:

Py

P
(2) Be = Boyt my, + mY, - Yh)

t Dt

The OECD's adjusted budget balance is then defined as in (3).

P)

0) = - -
(3) ABL = B my - ¥

t [= Bp

P.
t* m Y,J

and includes the budget balance originating in discretionary policy and
fiscal drag (or "structural" components) .6

Note that when the economy is growing along its potential growth
path the actual budget balance is the OECD structural balance. The O&CD.

adjusted balance gives a reasonable answer to the following question: What

6In the OECD's words: "The 'discretionary', or 'cyclically-corrected',
change is made up of two principal components: (i) The effect of existing
policies, reflected in the elasticity of taxes (e) and expenditures (g)
relative to the growth of potential GDP....; (ii) Changes in tax yields
(AR) and expenditures (AG) arising out of policy changes in year t." This
eyclically-corrected component is represented by the first three terms in
the equation below.

" ABE= ARE- AGE* (e(T/Y)o~ B(G/Y)o)AYE + m( AYg- AYE) .TM


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Table 2

ACTUAL AND ADJUSTED BUDGET BALANCES

ACTUAL OECD IMF DIFFERENCE
UNITED STATES (BILLIONS $):
x 1979 14.53 29.9 11.68 18.22
x 1980 -30.75 19. -3.12 22.12
x 1981 -26 .82 32.4 4.33 28.07
x 1982 115.28 3.5 -25.31 28.81
x 1983 7134.2 -22.3 -49.09 26.79
* 1984 -123.05 -51.7 87.53 35.83
JAPAN CTRILLIONS Y):
x 1979 7-10.43 “9.4 1.12
x 1980 -10.54 9.2 1.78
x 1981 -10.06 8.7 4.31
x 1982 9.58 8.3 5.15
x 1983 9.67 -7. 6.37
x 1984 -7.8 -5.8 7.23
GERMANY (BILLIONS DM):
x 1979 -35.63 27.9 -13.08
x 1980 42.95 32.2 14.39
x 1981 56.66 34.2 71.52
x 1982 52.52 12.4 32.16
x 1983 -41.16 8.8 46.29
% 1984 ' -33.82 12.2 44.29

!
FRANCE (BILLIONS FR):
x 1979 ' -16.7 -21.3 24.09 45.39
x 1980 5.9 14.1 77.24 63.14
x 1981 55.6 -23.7 66.82 -90.52
x 1982 97.24 -49.7 65.39 -115.09
x 1983 -120.92 -50.3 93.38 143.68
x 1984 -119.81 24.3 140.04 7164.34
UNITED KINGDOM (BILLIONS L):
x 1979 6.87 7.9 1.46
x 1980 -8.09 4.3 5.43
* 1981 “7.21 3.4 2.43
x 1982 6.49 5.7 16.47
* 1983 -11.18 “0.5 13.63 :
x 1984 12.34 "2.4 13.91 -16.31
ITALY CTRILLIONS L):
x 1979 25.74 “26. -0.98 -25.02
x 1980 27.22 "28.5 3.18 -31.68
* 1981 “47.9 48.5 -5.11 -43.39
* 1982 59.26 -57.3 -0.64 56.66
x 1983 66.7 60.7 9.44 70.14
% 1984 82.9 -76.1 5.1 81.2
CANADA (BILLIONS C$):
% 1979 “4.63 “4.1 1.68 -5.78
x 1930 8.1 6.3 0.28 6.58
fad 1931 5.44 “4.4 2.91 -7.31
1% 1932 717.89 6.5 4.4 -10.9
x 1933 24.12 14.1 0.12 -14.22
x 1934 26.7 -19, 5.26 -13.74


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- 18 -
Numerical estimates of these contributions are presented in table
8 for levels, table 9 for changes in levels, table 10 for ratios, and
finally table 11 for changes in ratios. As the tables reveal, a
considerable portion of the total discrepancy can be attributed to
differences in estimates of potential GNP by the two agencies, regardless
of whether one uses levels (ratios) or changes in levels (ratios). For
levels and ratio measures the United States data has a larger share of the
total discrepancy attributable to potential GNP estimates than either Japan
or Canada. For the change in levels form, Japan has the largest
discrepancies. For the change in the ratios data (table 11) there is no

clear pattern either within a country or across countries.

V. Conclusions

General Conclusions

The OECD and IMF measures of fiscal impulse differ in at least
four fundamental ways: (1) the OECD includes fiscal drag under the
presumption that it is part of the "structure" of fiscal policy, while the
IMF excludes it from its adjusted measure of the budget balance; (2) the
OECD and the IMF both adjust for cyclical factors but they do so
differently; (3) the OECD estimates its marginal tax and expenditure rates
from a structural model (m’, m8) whereas the IMF assumes unit.
income-elasticity of its parameters and uses historical average tax and
spending rates (tg, 8); and (4) each agency uses different estimates of

potential output.


International Comparisons of Fiscal Policies:
the OECD and IMF Measures of Fiscal Impulse

Introduction

Changes in a government's budget balance do not accurately
measure changes in fiseal policy. When budgets for different countries are
compared, measurement problems become more pronounced and complicated.

Both the OECD and the IMF periodically estimate and publish
measures of fiscal impulse to gauge the extent to which fiscal policy in
the major industrial countries has become more or less expansive over time.
The OECD employs a structural approach in that it attempts to calculate at
each point in time what the budget balance would be along some smoothly and
appropriately defined growth path. The IMF on the other hand, attempts to
measure the added stimulus of budgetary policies over some well defined
time period relative to the policies of a base period. This paper compares
the two.!

The paper concludes that the OECD and IMF measures of fiscal
impulse differ in at least four fundamental ways: (1) the OECD includes
fiscal drag under the presumption that it is part of the "structure" of
fiscal policy, while the IMF excludes it from its adjusted measure of the
budget balance; (2) the OECD and the IMF both adjust for cyclical factors
but they do so differently; (3) the OECD estimates its marginal tax and
expenditure rates from a structural model whereas the IMF assumes unit
income-elasticity of its parameters and uses historical average tax and

spending rates; and (4) each agency uses different estimates of potential

this paper focuses on the simplest form of adjusted budget balances which
are not adjusted for inflation, interest rates, and other factors.
Subsequent papers will focus on various adjustments to these measures.


-10-

A Conventional Budget Decomposition: A Short Digression

To clarify the conceptual differences in these measures, it is
useful to define budget balances as the sum of three terms representing the
following concepts: (1) discretionary policy; (2) budget items that expand
with the economy along trend (potential or mid-cycle trend, for example);
and (3) budget items that respond to cyclical fluctuations. Equation (8)

defines the budget balance in these terms.

(8) Ber Bost Bret Bes

The subscripts D, T, and C represent discretionary, trend, and cyclical
components, respectively.

Under this useful decomposition, the OECD adjusts actual changes
in the budget balance by removing its estimate of the cyclical component of

the budget balance:

0 . r_sg - P
(9) Boys (a m°y(Y, - YE)

The OECD adjusts the actual budget balance for cyclical revenues (m? (Ye -
YE)) and cyclical expenditures (m8 (Y, - YB)). The adjusted budget
balance in principle includes the discretionary surplus and fiscal dreg
(the surplus at potential output), both perceived to be structural elements
of policy.

The IMF adjusted balance can be interpreted as removing both the


-12-

government expenditures that deviate from unit elasticity with respect to

potential GDP and cyclical revenues that deviate from unit elasticity with

respect to actual GDP.

Differences in Adjusted Budget Balances

We can now return to the major objective of this paper. Equation
(13) below is a precise formulation of the difference between the OECD and
the IMF adjusted budget balance, where YO and YF represent potential cutput
estimates by the OECD and the IMF, respectively. Eq. (13) is derived by
subtracting eq. (7) from eq. (3).

) F O_ oF r ) F
(13) ABE ~ ABL = (BE - BL) ~ Em (¥,- YE) - ty(¥e- Yd]

g 0, _ «4 tg eotyyF _ F
+ Cm(X, - YE) - (UTB (egg) 1 + (tom Bo) YE

Differences in fiscal impulse measures arise because of
differences in adjusted budget balances. We can address the questions
raised in the introduction by closely examining differences in adjusted
budget balances. The first term represents differences in estimates cf the
actual budget balance arising, for example, from different accounting
procedures used by the OECD and the IMF. The second term accounts for
differences in estimates of cyclical revenues. The third term accounts for
differences in estimates of cyclical expenditures. Both the second and

third terms involve differences in parameter estimates and potential cutput

estimates as well as implicit methodological differences. The fourth term
accounts for the fact that the IMF removes the trend budget deficit whereas

the OECD does not.


Abstract

Both the OECD and the IMF periodically estimate and publish
measures of fiscal impulse to gauge the extent to which fiscal policy in
the major industrial countries has become more or less expansive over time.
This paper compares these measures analytically and numerically. The paper
shows that the OECD and IMF measures of fiscal impulse differ in at least
four fundamental ways: (1) the OECD includes fiscal drag under the
presumption that it is part of the "structure" of fiscal policy, while the
IMF excludes it from its adjusted measure of the budget balance; (2) the
OECD and the IMF both adjust for cyclical factors but they do so
differently; (3) the OECD estimates its marginal tax and expenditure rates
from a structural model whereas the IMF assumes unit income-elasticity of
its parameters and uses historical average tax and spending rates; and (4)
each agency uses different estimates of potential output. The paper then
numerically allocates differences in the published figures of the OECD and
the IMF to these various sources. The paper assesses the usefulness of
each measure.


IFDP
NUMBER

263

262

261

260

259

258

257

256

255

254

253

252

251

250

24g

International Finance Discussion Papers

TITLES

Some Implications of the President's Tax
Proposals for U.S. Banks with Claims on
Developing Countries

Monetary Stabilization Policy in an Open
Economy

Anticipatory Capital Flows and the Behaviour
of the Dollar

Simulating Exchange Rate Shocks in the MPS
and MCM Models: An Evaluation

Trade Policy for the Multiple Product
Declining Industry

Long Memory Models of Interest Rates, the
Term Structure, and Variance Bounds Tests

Currency Substitution and the New Divisia
Monetary Aggregates: The U.S. Case

The International Transmission of Oil Price
Effects and OPEC's Pricing Policy

U.S. Banks' Lending to Developing Countries:
A Longer~Term View

Conditional Econometric Modelling:
An Application to New House Prices
in the United Kingdom

Low Pushing: Doctrine and Theory

1984
(partial listing)
Postwar Financial Policies in Taiwan, China

Foreign Exchange Constraints and Growth
Possibilities in LDCs

The Determination of Front~end Fees on
Syndicated Eurocurrency Credits

Monetary Policy Games and the Role of Private

Information

AUTHOR(s)
Allen B. Frankel
Marcus H. Miller
Arnold Kling
Arnold Kling
Catherine Mann
Gary S. Shea
Jaime Marquez
Jaime Marquez
Henry S. Terrell
Rod Mills
Neil R. Ericsson

David F. Hendry

William Darity, Jr.

Robert F. Emery

Jaime Marquez

Rodney H. Mills
Henry S. Terrell

Matthew B. Canzoneri


Table 7

PARAMETER ESTIMATES USED IN NUMERICAL EXERCISES

OECD IMF
MARGINAL AVERAGE
MARGINAL TAX EXPENDITURE AVERAGE TAX EXPENDITURE
PARAMETER PARAMETER PARAMETER PARAMETER
(MG) (70) (G0)
-0.121 0.315 0.315
0.102 0.315 0.315
-0.116 0.315 0.315
-0.121 0.315 0.315
0.131 0.315 0.315
0.151 0.315 9.315
0.146 -0.005 0.246 0.302
0.182 0.005 0.246 0.302
0.171 -0.013 0.246 0.302
0.126 0.014 0.246 0.302
. 0.213 0.022 0.246 0.302
1984 0.225 0.02 0°246 0.302
!
CANADA \
1979.... 9.259 -0.074 0.385 0.417
1980. . "0.263 -0.077 0.385 0.417
1981... 0.319 -0.08 0.385 0.417
1982... 0.326 -0.087 0.385 0.417
1983... 0.304 -0.088 9.385 0.417
1984.02. 0.371 -0.09 0.385 0.417



International Comparisons of Fiscal Policy:
the OECD and the IMF Measures of Fiscal Impulse

Garry J. Schinasi, Economist*
International Finance Division
Federal Reserve Board
February 1986

* The author would like to acknowledge the most capable research
assistance of Joerg Dittmer. The paper benefited from encouragement and
comments from the staff of the International Finance Division at the Board
of Governors, particularly M. Gavin, D.H. Howard, K.H. Johnson, C. Mann,
and L.J. Promisel. The views expressed in this paper are those of the
author and should not be interpreted as the views of the Board of Governors
of the Federal Reserve System or its staff.


-20-
balance originates in changes in policy, either discretionary or
programmed?". The IMF measure would yield poor results in comparing budget
outcones of various fiscal policy proposals (which is where the structural
approach excels, as demonstrated by the Congressional Budget Office). And
the IMF approach cannot accurately answer the question, "How much must the
current balance be increased, using discretionary sources, to balance the
budget at some level of output?".

The OECD approach can in principle answer all these questions,
but it relies on parameter estimates from structural models that are not
necessarily accurate or even reasonable representations of the real world.
Major strengths of the IMF measure are its simplicity, that it requires
no scphisticated model or data, and that it yields results that are
qualitatively similar to the more complicated OECD measure. Each measure
is probably more reliable as an indicator of fiscal ease or tightness
within a country over time than it is as a quantitative measure comparing

fiscal impulse across countries.

Specific Conclusions

Section III of this paper created an allocation scheme for
explaining the difference between estimates of fiscal impulse measures.
This scheme allocated the total discrepancy to cyclical revenues, cyclical
expenditures, fiscal drag, and "other". One clear pattern that emerges is
that the exclusion of fiscal drag by the IMF accounts for a much smaller
share of the disrepancy in measures for the United States than for Japan

and Canada, regardless of whether one examines levels (ratios) or changes


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-8-
aggregate tax rates equal) while expenditures are unit elastic with respect
to potential GNP. These assumptions are not well motivated.
The actual budget balance, which excludes UIB for the
calculation, has two components: the cyclically neutral budget balance; and

everything else, which the IMF calls fiscal stance (FIS).

* Y YP 1s*
(5) BE = thy ~ Sot, ~ FISy

The adjusted budget balance is then the difference between the actual

budget balance and the cyclically neutral balance:7

F * * Pp *
(6) ABL = Be (toy, BY) (= FIS,]

Equations (3) and (6) are reproductions of the OECD and IMF methods for
calculating adjusted budget balances. To calculate the fiscal impulse, one
divides each measure by actual GDP (or GNP), takes first differences, and

changes the sign.

TIn the words of the IMF: "Such changes [in the adjusted balance] may be
viewed as policy determined either (1) by the introduction of new measures
or (2) by the operation of previously existing measures that automatically
result in revenue (expenditure) changing disproportionately to the change
in GNP (potential GNP) by which 'neutrality' is judged." (WEO , April 1985,
p.- 109)

"The net 'fiscal impulse’ (FI) may be expressed in terms of the change
in revenue (R), expenditure other than unemployment insurance benefits (E),
actual GNP (Y), and potential GNP (YP), as follows:

FIg= -(ARE- toAYt) + (AEE- SoAYPt)
where to and go are the base year ratios of revenue to actual GNP and of

expenditure other than unemployment insurance benefits to potential GNP,
respectively." (WEO, April 1985, p. 110)


-W1-
trend component (or fiscal drag) and a cyclical component, eq.(11) and

eq.(12), respectively.8

F P
(11) Boyz (ts - 8) XY

F P Pp
(12) Bogs ty (E> YE) {UIB, eX]

In summary, the OECD subtracts cyclical revenues and expenditures
from actual budget balances to derive its adjusted budget balance. Its
adjusted balance includes discretionary budget items and income sensitive
components of the budget that would change along a trend growth path.

The IMF, on the other hand, subtracts its estimate of cyclical revenues and
expenditures and also subtracts the budget balance at potential GDP
assuming policy (parameters) has not changed since the base period. The

IMF's adjusted balance includes discretionary budgetary items and cyclical

8 decompose the IMF measure in this way let the actual budget balance be
composed of three elements: a "base year surplus," chosen in a period when
actual and potential output are roughly equivalent; a cyclical component;
and the fiscal stance. This is represented in the equation below and is
equivalent to eq.(7) in the text.
P P P
B= (t-g)yY +{t (Y-Y¥) - (UIB- py )] - FIs.
t o oo t ot t ° t t

The first term represents the base year surplus, with to and Bo defined
as the ratios of receipts and expenditures to output measured in the base
year, a time period when actual and potential output are equivalent (or
nearly so). This term then represents the full-employment budget surplus
in time period t, under the policies in force in the base period (where to
and go represent the "policies"). The second term represents cyclical
revenues less cyclical expenditures. Whenever actual output is greater
than potential, total receipts will exceed full-employment receipts and the
actual budget deficit will include these receipts. Cyclical expenditure is
estimated by cyclical unemployment insurance benefits (actual UIB minus
what would be paid out at potential assuming the base period payout ratio).
The fourth term, FIS, includes discretionary policy changes since time
period 0 and represents the IMF's view of the "thrust" of fiscal policy.