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The Econometrics of the EU Fiscal Governance: is the European Commission methodology still adequate?

Marco Fioramanti and Robert Waldmann ()

MPRA Paper from University Library of Munich, Germany

Abstract: Following the 2005 regulations emending the Stability and Growth Pact with the introduction of country-specific objectives in structural terms, the EU fiscal governance is based on the concept of Potential Output, the highest level of production an economy can sustain without incurring inflationary pressure. Potential Output is an unobservable quantity and, for this reason, it must be estimated. There are many techniques to obtain an estimate of the potential of an economy, each of which with pros and cons. The methodology adopted by the European Commission and EU Member States, while consistent with most of the recent economic and econometric theory, is still not robust enough to give a unique and irrefutable measure on which to base EU’s fiscal framework. In this paper, we challenge the EC's approach showing its failure to adequately capture the relation between inflation and cyclical unemployment, the Phillips curve, in estimating the trend unemployment. Should fiscal policy continue to be based on this concept, further extension of the methodology must be implemented in order to obtain more robust estimates.

Keywords: Potential output; Output gap; Structural balance; NAWRU; Phillips curve (search for similar items in EconPapers)
JEL-codes: C10 E32 E60 H60 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec and nep-mac
Date: 2017-09-15
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