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Nominal exchange rates against the US dollar are generally assumed to remain constant over the projection period, at the level prevailing on a pre-specified cut-off date except for countries where this contrasts with stated or de facto exchange rate policies. There are two reasons for this assumption. Firstly, forecasts of exchange rates continue to be politically very sensitive in many countries. Secondly, it has proved to be very difficult to arrive at acceptably accurate forecasts of short term exchange rate movements, and in practice, a naive model, assuming that exchange rates are constant in nominal terms, has not proven to be much more inaccurate than those generated by econometric models. The fixed exchange rate assumption is modified for Turkey where it is assumed that the lira depreciates in line with the projected inflation differential vis-à-vis the United States, reflecting the OECD Secretariat's interpretation of "official exchange rate policies":
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Unchanged fiscal and monetary policies
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The assumption that macroeconomic policies are assumed to be "unchanged "over the projection period does not imply that the OECD Secretariat necessarily assumes that governments will - or, indeed, should - achieve their stated objectives. Rather this assumption, as already noted elsewhere, serves to illustrate what are the likely outcomes for growth, inflation and employment given announced policies.
Fiscal policy. Fiscal policy assumptions are based on announced measures, and stated policy intentions where they are embodied in well-defined programmes. There may be large margins of error around the "point forecasts" of fiscal positions, reflecting uncertainties about:
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Economic growth rates and inflation rates.
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Income elasticities of tax revenues, especially in the event of tax reforms.
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Impacts of new cyclical measures (e.g. in the labour market).
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Calendar year estimates for countries whose fiscal year does not start on 1 January (i.e. Australia, Canada, Japan, New Zealand, United Kingdom and the United States).
The OECD Secretariat uses a wide range of fiscal indicators to evaluate the overall fiscal situation of Member countries. No single indicator captures all the information about the fiscal situation but evaluating the situation by looking at a range of them should help to counterbalance the short-comings of each single one. Moreover, any assessment of the fiscal situation must look at the evolution of the indicators over a period of several years since looking at one year alone could give a distorted picture, given changes in economic conditions, one-off factors, etc.
The most widely used indicator is the general governement financial balance or net lending. Besides being an indicator of the accumulation of government debt, net lending is also an important summary measure of the extent to which government's budgets contribute to macroeconomic stabilisation. As a related concept, the primary budget balance is derived from the overall financial balance by excluding the impact of net interest payments (which reflect the “fiscal inheritance” i.e. debt built-up in the past). Thus, the primary balance is derived by adding back net interest payments to the overall budget balance. Along with the overall balance, the primary balance is mainly used for the analysis of debt dynamics.In order to get a clearer picture of the underlying fiscal situation and to use this as a guide for fiscal policy making, it is useful to try to correct the actual financial balance (net lending) for the fiscal impact of cyclical changes in economic activity. The cyclically-adjusted budget balance represents what government revenues and expenditure would be if output were at its potential level (for a more detailed exposition of the methodology see Van den Noord (2000) and Girouard and André (2005)). Moreover, in evaluating the stance of fiscal policy it is often useful to correct the cyclically adjusted balance for interest payments on government debt since these payments do not represent discretionary spending items. Thus, the primary cyclically-adjusted budget balance is derived by adding back net interest payments to the cyclically-adjusted balance. Changes in the primary cyclically-adjusted balance can then be used as a rough indicator for changes in discretionary fiscal policies.
In assessing public finance positions, attention is also paid to the general government's consolidated gross financial liabilities which measure the total debt held outside the government's accounts and provides an indicator of the likely future debt servicing burden of the economy. It should be noted that measured debt does not give a complete picture of debt servicing burdens, as it generally excludes contingent liabilities and assets (i.e. pensions, health care, deferred taxes) and the value of the government's real assets. The "true" value of the government's financial assets is also often difficult to gauge (e.g. government loan programmes and holding of shares in state owned enterprises). Nevertheless, the size of government debt is a key variable for estimating and evaluating issues related to fiscal sustainability and the room of manoeuvre for fiscal policy.
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Domestic monetary policies
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For the major economies, monetary policy is assumed to be set so as to achieve stated objectives. This takes into account a range of monetary indicators, policy announcements with respect to the choice of monetary targets, associated target ranges and instruments, by national authorities. The resulting path of short-term interest rates feeds into longer term interest rates in a manner consistent with the expectation hypothesis of the term structure of interest rates (see
Interest rate assumptions underpinning the OECD's projections (2006)).
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Oil and non-oil commodity prices
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Given the volatility of oil prices, the OECD has adopted, as a working hypothesis, the assumption that the price of Brent crude remains constant over the respective projection period, at a level equalling the average price over the four weeks prior to the cut-off date for information used in the projections.
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