Budgetary Wishful Thinking

CAMBRIDGE – Why do many countries find it hard to control their budgets? Concern about budget deficits has become a burning political issue in the United States; helped to persuade the United Kingdom to enact stringent cuts, despite a weak economy; and is the proximate cause of the Greek sovereign-debt crisis, which has grown to engulf the entire eurozone. Indeed, among industrialized countries, hardly anyone is immune from fiscal woes.

Clearly, part of the blame lies with voters who don’t want to hear that budget discipline means cutting programs that matter to them, and with politicians who tell voters only what they want to hear. But another factor has attracted little notice: systematically over-optimistic official forecasts.

Such forecasts underlie governments’ failure to take advantage of boom periods to strengthen their finances, including running budget surpluses. During the expansion of 2001-2007, for example, the US government projected that budget surpluses would remain strong. These forecasts supported enactment of large long-term tax cuts and faster spending growth (both military and otherwise).

European countries behaved similarly, running up ever-higher debts. Not surprisingly, when global recession hit in 2008, most countries had little or no “fiscal space” to implement countercyclical policy.