Testing EU fiscal surveillance: how sensitive is it to variations in output gap estimates?

Sven Langedijk and Martin Larch

International Review of Applied Economics, 2011, vol. 25, issue 1, 39-60

Abstract: Real-time estimates of potential output are used for the calculation of the cyclically adjusted budget balance, one of the main indicators in the assessment of the fiscal performance of EU member states. The estimation of potential output involves a decomposition of actual output into a cyclical and a structural component based on arbitrary assumptions about the statistical properties of the two unobserved components. With a very high degree of smoothing, variations in GDP are mostly taken to be temporary, as are the ensuing changes in the budget deficit. Conversely, with a low degree of smoothing, variations in GDP are mostly taken to be permanent, leading to different policy conclusions. Our paper examines whether and how different potential output estimates would have supported different decisions in the EU budgetary surveillance in terms of both timing and substance. The results show that only a very high degree of smoothing of potential output would significantly reduce the reliability of the surveillance indicators. We conclude that a higher degree of smoothing compared with current practice would not be harmful for EU fiscal surveillance, while it could contribute to more cautious policies by signalling larger and longer periods of economic 'good times'.

Keywords: potential output; cyclical adjustment; EU budgetary surveillance; Stability and Growth Pact; Excessive Deficit Procedure; safety margin; minimum benchmark; fiscal surveillance indicators (search for similar items in EconPapers)
Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/02692170903426138 (text/html)
Access to full text is restricted to subscribers.

Related works:
Working Paper: Testing the EU fiscal surveillance: How sensitive is it to variations in output gap estimates? (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:irapec:v:25:y:2011:i:1:p:39-60

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/CIRA20

DOI: 10.1080/02692170903426138

Access Statistics for this article

International Review of Applied Economics is currently edited by Professor Malcolm Sawyer

More articles in International Review of Applied Economics from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().