The Role of Endogenous NAWRU in Reducing the "Space of Forgiveness": a Theoretical and Empirical Appraisal of the European Fiscal Framework

Giovanni Carnazza, Emilio Carnevali and Matteo Sommacal

Discussion Papers from Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy

Abstract: The European Union's fiscal policy framework imposes constraints on individual countries' fiscal policies to ensure long-term financial sustainability. However, it is also designed to provide flexibility through the operation of "off-balance" automatic stabilisers. In practice, these rules have led to pro-cyclical measures in EU peripheral countries due to the way European institutions estimate the Non-Accelerating Wage Rate of Unemployment (NAWRU). The paper demonstrates the pro-cyclical nature of the current mechanism by combining empirical evidence covering the period 2002-2023 with a semi-analytical model of the potential output and NAWRU dynamics to estimate the change in the Cyclical Component due to the endogenisation of the variables relevant to the business cycle. Since the recent reform of the Stability and Growth Pact has maintained the core of this mechanism, the challenges identified for the period 2002-2023 are likely to persist in the upcoming years as well.

Keywords: National Budget; Aggregate Production Function; Fiscal Policy (search for similar items in EconPapers)
JEL-codes: E23 E62 H61 (search for similar items in EconPapers)
Date: 2024-11-01
New Economics Papers: this item is included in nep-eec
Note: ISSN 2039-1854
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Persistent link: https://EconPapers.repec.org/RePEc:pie:dsedps:2024/316

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