The Econometrics of the EU Fiscal Governance: is the European Commission Methodology Still Adequate?
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Following the 2005 regulations emending the Stability and Growth Pact, 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. The method used by the European Commission and EU Member States to estimate potential output, 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.
keywordsPotential output, Output gap, Structural balance, NAWRU, Phillips curve. |
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