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Prudent Economic Assumptions

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Practice Advice on Public Financial Management

Prudent Economic Assumptions (OECD)

Summary AdviceThe OECD advises that deviations from the forecast of the key economic assumptions underlying the budget are the government’s key fiscal risk and that it is important to make prudent economic assumptions.

Main Points: The OECD states that there is no single factor more responsible for “de-railing” fiscal consolidation programmes than the use of incorrect economic assumptions. It recommends the following to guard against the use of unrealistic, or “optimistic,” economic assumptions.

  • Great care must be taken in making economic assumptions.
  • All key economic assumptions should be disclosed explicitly.
  • Sensitivity analysis should be made of what impact changes in the key economic assumptions would have on the budget. 
  • A comparison should be made between the economic assumptions used in the budget and what private sector forecasters are applying for the same time period where practicable.
  • The establishment of an independent body to recommend the economic assumptions to be used in the budget may be considered as well.

Two member countries, Canada and the Netherlands, have established safeguard features that are leading-edge practices among member countries. These policies help to achieve public and financial market credibility and act as an insurance policy against revenue fluctuations.

The practices started by the Canadian government are:

  • Systematically-biased “prudent” economic assumptions based on the average of forecasts made by private sector economic forecasters – and then adjusting them downwards. Forecasts are adjusted downwards by the government adding 50-100 basis points (0.5-1.0 percentage point) to the average private sector economic forecasts for interest rates and then feeding this through its entire econometric model, thus producing lower forecast economic activity. 
  • Incorporating a contingency reserve 2.5-3.0 billion Canadian dollars each year. This fund can only be used to compensate for forecasting errors and unpredictable events. It cannot be used for any new policy initiatives. Recourse has never had to be made to the contingency reserve funds and they have been applied to deficit reduction (surplus) in their entirety in each year.

The practices started by the Dutch government are:

  • Controlling the level of expenditures through expenditure caps that were based on cautious economic assumptions for the economy.
  • Economic assumptions are made by the independent Central Planning Bureau (CPB). The CPB will present two economic scenarios to the government. The first one is what it considers to be the most likely level of economic growth. The second one is what it considers to be a cautious level of economic growth that should be used for budget policy purposes. The government then applies the cautious scenario.

Source: OECD (2003). Budget Reform in OECD Member Countries: Common Trends at http://www.oecd-ilibrary.org/governance/budget-reform-in-oecd-member-countries-common-trends_budget-v2-art20-en (accessed 20 October, 2012).

Page Created By: Matthew Seddon on 1 November, 2012. Updated by Ian Clark on 4 January 2013. The content presented on this page is drawn directly from the source(s) cited above, and consists of direct quotations or close paraphrases. This material does not necessarily reflect the official view of the publishing organization. 


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School of Public Policy and Governance