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Adding a fiscal rule into a DSGE model: How much does it change the forecasts?

Andeyev M.

We tried to answer two questions: does the fiscal rule, used in Russia since 2017, stabilize macroeconomic indicators? If so, does the fiscal rule help to improve the quality of forecasts? We found that the legislation relating to the fiscal rule does not clearly define the dynamics of fiscal debt, but only sets an upper limit. This makes it necessary to independently define the model dynamics of fiscal debt. We then extended the DSGE model used by the Bank of Russia with a description of the fiscal sector. We estimated the extended model using Russian data. In theory, at the level of impulse response functions, the fiscal rule leads to a decrease in output volatility, a slight decrease in exchange rate volatility and a stronger disinflationary effect in response to a positive oil price shock. Making forecasts on a short time interval from 2017 until 2019 shows that the use of the fiscal rule in the model does not improve the forecast quality: the quality of the inflation forecast remains the same and the quality of the GDP forecast worsens. This means that simpler descriptions than the fiscal rule can be used to forecast budget variables. The fiscal rule can be used to model qualitative shifts in fiscal policy.

Adding a fiscal rule into a DSGE model: How much does it change the forecasts?

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Last updated on: 22.06.2021