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The idea is that we create something we call the European Fiscal Mechanism, the EFM. This is an independent organization which is tasked with estimating the aggregate European output gap. If it detects such an output gap, it injects fiscal assets (i.e. cash) into the state budgets of all Euro member nations, in some way which is seen as fair. Say, a country which makes up 20% of the Euro economy gets 20% of the cash, no matter if it has an actual output gap or not.
Okay... EU Balks at Changing Deficit Rule to Ease Austerity (WSJ, September 25, 2013)
The change was approved by technical experts at a meeting last week and was expected to be supported at a Tuesday meeting of more senior officials in Brussels. But an article published in The Wall Street Journal about last week's decision generated concern in some national capitals about its effects on budget policies, an EU official said.

...

The change involves a highly technical methodology that the European Commission, the European Union's executive arm, uses to calculate the "structural deficit," which is the actual budget deficit adjusted for the strength of the economy. The commission uses the structural deficit to determine how much austerity governments will need to undertake to meet EU budget targets.

...

Europe's current calculations about how much of the deficit is structural and how much is caused by the downturn in the business cycle assume much of the budget deficits seen in the bloc's weakest economies are built-in, meaning they will persist even after the economy has returned to full strength. If a deficit is structural, rather than cyclical, more austerity measures--spending cuts or higher taxes--are required.



A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed Jul 23rd, 2014 at 05:30:01 AM EST
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Europe's current calculations about how much of the deficit is structural and how much is caused by the downturn in the business cycle assume much of the budget deficits seen in the bloc's weakest economies are built-in, meaning they will persist even after the economy has returned to full strength. If a deficit is structural, rather than cyclical, more austerity measures--spending cuts or higher taxes--are required.

I am trying to figure out what formal school of economics would lead to this conclusion. Austrian? The prescription seems to be 'if the patient is ill, amputate. Still not well? More Amputation.' The economics of cannibalism.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Jul 25th, 2014 at 10:16:59 PM EST
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This is mainstream neoclassical NAIRU bullshit. Read this revised methodology for calculating output gaps [PDF] and weep.

Also, Noahpinion has a guest post on How important was the "structural balance" screw-up in driving European austerity? (October 05, 2013) describing what's wrong with the European Commission's econometrics.

The European Commission uses a production function methodology for calculating potential growth rates and output gaps (see here). It features a simple Cobb Douglas specification where potential output depends on TFP and a combination of factor inputs (potential labor and capital). Importantly for what follows, potential labor input is calculated as:

Working age Population x Participation rate x Average hours worked x (1 - NAWRU)

It's important to focus on potential labor input since the bulk of the revisions applied between 2008 and 2010 to potential GDP arose because of revisions to labor input.

And note the use of NAWRU rather than NAIRU. If you use NAIRU (non-accelerating-inflation rate of unemployment) you're using unemployment as a policy lever to achieve an inflation policy target. But if you use NAWRU (non-accelerating-wages rate of unemployment) you're using deliverately using unemployment to depress wages, but hiding that under a supposedly objective econometric model.

It really is criminal.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Sat Jul 26th, 2014 at 12:07:58 AM EST
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Then the intellectual heritage would be  Keynesian Synthesis, per Samuelson and Phillips, but grossly perverted by Monetarists and further perverted by compromizing with Keynes rejectionists from the original version of Neo-Classical Economics.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sat Jul 26th, 2014 at 11:38:00 AM EST
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