An analysis of the impacts of GDP revisions on cyclically adjusted budget balances (CABS)

Trend (potential) GDP estimates, and consequently output gaps, a key variable for calculating cyclically adjusted balances (CABs), are unobservable and depend on past and projected observations. Thus, revisions to output forecasts lead to changes in CAB estimates, even if no additional discretionary measures have been taken. This paper presents an analysis of the impact of revisions to economic growth projections on the levels of and changes in structural balances when the Hodrick-Prescott filter is used to estimate the output gap. Two main conclusions are obtained. Firstly, economic growth revisions affect both the output trend and output gap, and thus CABs, to a degree that depends on whether the revisions have a temporary or permanent effect on the GDP level. Transitory changes in the level of output are mainly allocated to the cyclical component and CAB levels are little affected. If, however, the revision implies a permanent change in GDP level, CABs will be affected to a larger extent. Secondly, it is also shown that the impact of economic growth revisions on CAB changes is much more limited than on CAB levels. Given that the change in structural balances due to GDP revisions cannot be attributed to fiscal policy actions and that it can be easily calculated, we argue that this factor should be recognised when judging the ex-post compliance of EU countries with the rules of the Stability Pact