Structural Budget Balance and Fiscal Policy: the Limits of the European Approach

Year 2015, Volume: 1 Issue: 2, 19 - 34, 11.06.2016

Stefano Fantacone Petya G. Garalova Carlo Milani

Abstract

Under the Fiscal Compact’s rules, the structural balance has become a crucial variable in the EU budgetary framework. This should facilitate the operativeness of the automatic stabilizers and avoid pro-cyclical fiscal policies . However, in the past years peripheral
member countries have witnessed a widespread budget restriction in front of a deep downturn of the economic cycle. We show that this occurred due to the distorted information provided by the model used by the European Commission to calculate the structural budget balance. Starting from the direct relationship between this latter and the NAWRU, we shed some light on the estimation methodology and its implication on member states’ fiscal policy. We focus our attention on the poor economic significance of the NAWRU and its large volatility over time. Finally, by the means of panel data estimations, we find out that the NAWRU is correlated with the economic cycle, which implies pro-cyclical effects on structural balances. Peripheral European countries seem to be more affected by these pro-cyclical effects than core countries.

Keywords

Potential GDP, Structural Balance, Non-Accelerating Wage of Unemployment, Fiscal Rules, Austerity

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