Fiscal rules based on structural budget deficits. Can the ...
Transcript of Fiscal rules based on structural budget deficits. Can the ...
Fiscal rules based on structural budget
deficits. Can the methodology be improved? Meeting on Assessing the European Fiscal Framework
Brussels, Bruegel seminar, November 17, 2014
Lorenzo Codogno
Italian Ministry of Economy and Finance
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Fiscal rules: are they fit for prolonged stagnation?
Supply-side reforms: How can we provide incentives for reforms within the existing fiscal framework? Do CAB estimates need to consider the effects of reforms?
Lack of aggregate demand: Is the current policy mix a correct stance for the Euro Area? Have CAB estimates factored in lack of demand?
Are European fiscal rules appropriate for the current economic environment? Can fiscal rules based on structural budget deficits be improved?
THE CURRENT ECONOMIC POLICY SCENARIO
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What is the post-crisis potential of the economy?
MACROECONOMIC TRENDS
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-4
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0
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6
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-2
0
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1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
% y
ea
r-o
n-y
ea
r
% y
ear-
on
-year
Eurozone France
Spain Italy
Germany Core
Periphery United States
Source: Eurostat, BEA, European Commission (forecasts)
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Are GDP level losses going to be recovered?
MACROECONOMIC TRENDS
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90
100
110
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90
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110
120
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Ind
ex
20
08
=1
00
Ind
ex
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08
=1
00
Germany France Spain
Italy Eurozone Core
Periphery United States
Source: Eurostat, BEA, European Commission (forecasts)
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Revisions are partly due to different forecast horizons
SOURCES OF REVISIONS FOR ITALY
Source: IT 2015 Draft Budgetary Plan and 2014 Commission Autumn Forecasts
Very negative potential growth: hysteresis issue. How much is real and how
much is derived from the model itself?
AF2014 and DBP: very similar GDP growth forecasts for 2014-2016. Yet
substantial differences in OG and potential growth.
Different forecast horizon: 2018 for DBP vs 2016 for AF2014.
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-4
-3
-2
-1
0
2013 2014 2015 2016
Output gaps
IT output gap (DBP) IT output gap (AF2014)
-0,6
-0,4
-0,2
0
0,2
2013 2014 2015 2016
Potential Growth
IT pot growht (DBP) IT pot growht (AF2014)
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Labour contributions to potential growth
SOURCES OF REVISIONS FOR ITALY
Source: Commission Forecasts - different vintages
Small revisions in total hours growth determine changes in the Solow Residual
and, in turn, in TFP.
For Italy need to check hours worked. There are probably inconsistencies due to
“Cassa integrazione” (wage supplementation fund).
-0,3
-0,2
-0,1
0
0,1
2008 2009 2010 2011 2012 2013 2014
AF14 SF14 WF14 AF13 SF13
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-1
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1
2008 2009 2010 2011 2012 2013 2014 2015 2016
AF14 SF14 WF2014 AF13 SF13
Growth in total Hours TFP contribution to Potential
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NAWRU revisions: impact of variance bounds as of SF12
SOURCES OF REVISIONS FOR ITALY
Source: Commission Forecasts - different vintages
The 2012 rise in unemployment led to an upward revision of the NAWRU.
For a given set of data, many combinations of variance bounds with different
outcomes both for real time and forecast estimates.
Large pro-ciclicality over the forecast period due to variance bounds.
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WF13 SF13 AF13 WF14 SF14 AF14 Unemployment rate SF12
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IT NAWRU estimates: Discretionary cycle variance bound
SOURCES OF REVISIONS
Source: Italian 2015 DBP and Commission recalculation
With higher variance bounds, DBP NAWRU are more stable at the end of the
forecast period (partly due to the expected impact of structural reforms).
With lower variance bounds, NAWRU recalculated by Commission increases at
the end of forecast period (no apparent meaning).
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IT 2015 DBP IT DBP (with SF14 bounds) Unempl rate Comm (recalculated - new bounds)
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Phillips curve: very poor fit for Italy
SOURCES OF REVISIONS FOR ITALY
Source: 2014 Autumn Commission Forecasts
Phillips curve for Italy must be completely revisited.
Solution: anchored inflation expectations as in new OECD model?
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Time
Observations (- -) and fitted values
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NAWRU estimates on Italy
METHODOLOGICAL REMARKS
Too much discretion in managing variance parameters.
For Italy, the pro-ciclicality of NAWRU is due to the
interaction between trend and cycle bounds.
Different estimation strategies: the Commission (Italy)
decreases (increases) cycle bound variances over time
increasing (stabilising) NAWRU over the forecast period
need to find ways to reconcile the two strategies.
Need to better reflect on the underlying macroeconomic
assumptions.
Explore new models such as the one of the OECD.
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Potential labour contribution
METHODOLOGICAL REMARKS
With the exception of the NAWRU, each variable is
extrapolated “out of sample” by univariate autoregressive
models and then filtered with HP filter.
A univariate extrapolation process increases the probability
of forecast errors even in real time.
Need for a multivariate method for estimating the whole
potential labour contribution (e.g. vector autoregressive
model).
Quarterly frequency to combine timely statistical information.
)1(** ttttt NAWRUHOURSTPOPWPARTSL
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Can procedural improvements be introduced?
PROCEDURAL IMPROVEMENTS WITHOUT CHANGING THE METHODOLOGY
Extend the Commission forecast horizon: same horizon for
MSs and Commission estimates (possibly the one included in
Stability and Convergence programmes).
Decentralised process: give to Commission’s country desks
the possibility to estimate potential output and make the
underlying macroeconomic assumptions.
Discuss EC/MS forecast beforehand: wider OGWG mandate.
No recalculation by the Commission of MSs’ estimates,
especially when these estimates are certified by fiscal councils.
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Can the CAB methodology be improved?
Well-identified drawbacks mainly due to potential output and output gap measurement. We have to live with them.
CAB are very volatile indicators subject to deep revisions which have become larger in recent years. The objective of any change in the methodology should be to limit volatility and revisions, and thus the risk of excessively tight pro-cyclical policies.
Promising results at the OECD.
Economic judgement must play a role.
CONCLUSIONS