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Tuesday, December 29, 2015

NAWRU IV The Long Term

Guest post by Marco Fioramanti explaining how the EC "reconciles" the NAWRU Phillips curve model with completely implausible long term implications with their long term forecasts. Brief summary -- they don't take the model seriously.

by Marco Fioramanti

At this link you can find an EC's WP in which they distinguish between NAWRU and Structural Unemployment.

  They say (pg 1 link above):

“(...) Importantly, this method [the Unobserved Component Model for NAWRU - mf] provides only a proxy for structural unemployment that might not remove fully the impact of all temporary shocks. In particular, persistent shocks are likely to contaminate the trend.”

  Macroeconomic projections for the forecast and the fiscal stuff in EC works this way:

  1. Country desks do the forecast up to t+1/t+2 depending on the season (t+1 in spring, t+2 in autumn).

2. The service in charge of the estimation of potential output and output gap takes the numbers from (1) applies the methodology (production function approach called PF below) and go to t+5. In doing this a set of rules (on top of the PF approach) is used to extend the projection horizon, one of which is that the output gap closes in t+5. These estimations are at the core of the SGP.

3. EC also has long term projections for long term sustainability of public finance (pension, health care etcAgeing-related expenditure) which goes from t+10 to t+50. This is a simplified PF approach. To link t+5 to t+10 they have introduced a modified version of PF(t+5) methodology in which they anchor NAWRU to converge to structural unemployment in t+10 (for Italy structural unemployment is 9.4% according to EC’s latest estimate).

They say (pg. 39 in this WP ):

            “The NAWRU framework incorporates economic rationale into the T+10 NAWRU forecast, relying on a set of four labour market economic indicators (i.e. unemployment benefit replacement ratio; tax wedge; active labour market policies; & union density) and a set of macro control variables (i.e. TFP; real interest rate; employment in construction; & the T+5 NAWRU) to guide the forecast beyond T+5. This approach allows for a decomposition of the NAWRU into structural drivers and medium term cycles & for a prediction between T+6 and T+10 which reverts the NAWRU back towards the long run structural unemployment rate. A simple convergence rule towards the T+10 NAWRU is applied & a so-called prudent rule is built into the approach in order to override the calculations in cases where the T+10 NAWRU forecast is deemed to be surrounded by a relatively high degree of uncertainty for a particular country.”

So, while EC recognizes the NAWRU is too cyclical, they keep using it.

Fioramanti, Padrini and Pollastri (2015) propose (among others methodologies) using structural unemployment instead of NAWRU in the PF approach also for the t+5 projections - so the estimate of the natural rate of unemployment used in calculating the output gap would be the natural rate of unemployment as originally defined by Friedman. Endnote: In contrast to the t+5 methodology (for which you can get all the necessary files and instructions to replicate EC’s results) the t+10 methodology is not fully public.

 -- Marco Fioramanti

Comment by Robert Waldmann

It is very important that the EC doesn't take the I(2) NAWRU model seriously.  They have a model used for long term forecasts and another model used to calculate the NAWRU and cyclical unemployment = unemployment - NAWRU.  The NAWRU is used only to calculate the output gap and allowed deficits under the stability and growth pact (SGP). The bad long term implications of policies with good effects in the short term is the justification for the SGP *and* the claim that the concept of the natural rate of unemployment has policy relevance.

The estimates of cyclical unemployment include a series of arbitrary fudge factors NAWRU minus structural unemployment called "medium term cycles". There is no explanation of the cause of "medium term cycles".  The model of "medium term cycles" is not a model of "cycles" as the word is used in macroeconomics, because NAWRU-structural unemployment is not stationary.

It is hard to justify the use of a model (the NAWRU accelerationist Phillips curve discussed in these posts) with absurd long term implications which are ignored when making long term forecasts in the application of the SGP. I think there are two possible explanations of this modelling strategy. First it is possible that the technicians were instructed to make the accelerationist Phillips curve work and overcome all challenges from the data. Second it is possible that DG EcFin is willing to allow deficts over 3% of GDP because of cyclical corrections but only so long as the cyclical corrections are small. This corresponds to dividing the cycle into a "medium term cycle" with huge variance which has no role in a short term cycle with small variance (based on which Treasuries are given some slack) .

In any case, I certainly agree with Fioramanti, Padrini and Pollastri's proposal to use unemployment minus structural unemployment when estimating output gaps.

Monday, December 28, 2015

Global Warming Update

To celebrate the Paris peace talks and in honor of the Christmas season it has been almost unpleasantly hot in the Washington DC area (interesting how the people who laugh at Al Gore whenever it snows aren't mentioning this).

I am in my parents house in Silver Spring Maryland. On Christmas day it was so hot in their house that we used a fan to cool. We didn't turn on the air conditioning in December only because we didn't want to contribute to the global problem.

Here is a photograph taken (by Richard Waldmann) December 27th 2015 of Forsythia's blooming in Silver Spring Maryland

Friday, December 25, 2015

NAWRU III Hysteresis

This is the third of a series of posts on the non accelerating wage inflation rate of unemployment (NAWRU) estimated by the European Commission. In the first, I argue that this estimate is very important because it is used to implement the Stability and Growth Pact. In the second, I argue that the NAWRU is not well defined if there are anchored expectations or if there is downward nominal rigidity, and that there is strong evidence of both in 21st century Italian data (and therefore no hint at all that the NAWRU is a concept useful for those attempting to estimate the current Italian output gap). This post was a general overview and promise of future blogging.

When estimating the NAWRU the European Commission staff imposes the assumption that it shifts exogenously. The assumption is that the NAWRU is I(2) that is that the first difference of the first difference of the NAWRU is stationary. This implies that the NAWRU will almost certainly *not* remain in the interval from 0% to 100%. This makes no sense, but, in this post I will focus on the assumption that the disturbance terms which shift the level and the trend of the NAWRU are independent of all other variables. This means that the NAWRU is assumed to be genuinely exogenous -- not just exogenous to the model but exogenous to the economy, and, in particular, not affected by monetary or aggregate fiscal policy. This means that when unemployment is decomposed by total unemployment = NAWRU + cyclical unemployment, the conditional distrubtion of the NAWRU depends on past NAWRU but is independent of current and past cyclical unemployment.

The assumption that these shifts are exogenous is extremely important. An alternative view (discussed in 1960 in the second major article on the Phillips curve) is that structural unemployment is not exogenous because, with time, cyclical unemployment can become structural. This possibility was discussed and named "hysteresis" by Blanchard and Summers in 1986. They and Eugenio Cerutti have returned to the topic and presented massive evidence that it is important in (pdf warning) 2015.

The assumption that the NAWRU is not affected by aggregate demand is not easily reconciled with the fact that, in the 21st century, the estimate NAWRU closely tracks total unemployment. This must be true of estimated NAWRUs as inflation has remained stable in Eurozone countries (warning same pdf to which I linked in an earlier post).

The hypothesis that the NAWRU is exogenous can be tested by embedding the model used by the Commission in a more flexible model. One possibility (actually explored by the commissions DG EcFin) is to allow the acceleration of wage inflation to depend on lagged shifts in total unemployment. I have estimated both the official model and this more flexible model by maximum likelihood. My impression (that is the output of a program I wrote but don't swear by) is that the null of the official model is strongly rejected against the alternative. In any case, Blanchard, Cerutti and Summers present strong evidence that recessions often appear to have long lasting effects. The general pattern of European unemployment and wage inflation from 1980 on is of huge long lasting shifts in unemployment and a single huge decline in wage inflation in the 80s.

The assumption that the NAWRU is exogenous and must simply be accepted by fiscal authorities is critically important. If austerity causes an increase in the NAWRU, it can be self defeating. There is now overwhelming evidence that, especially when the safe short term interest rate is near zero, reduced government spending causes lower GDP and higher unemployment (pdf warning). If cyclical unemployment becomes structural, this implies a long lasting reduction in revenues and a long lasting increase in social insurance transfers. As noted by DeLong and Summers (pdf warning), this can imply that reduced government spending causes a higher long run debt to GDP ratio. The technical assumption that the NAWRU is exogenous has fundamentally important policy implications. It can be tested.

The econometricians at the Commissions DG EcFin are placed in a difficult position. They are required to look at data to apply the stability and growth pact, but they are not allowed to estimate parameters which suggest that the stability and growth pact causes instability and stagnation.

Tuesday, December 22, 2015

NAWRU II . There is no such thing as a NAWRU

This is the first of five posts I promised to write in this post.

NAWRU stands for the Non Accelerating Wage inflation Rate of unemployment. It is a concept used by the European Commission when deciding how much to allow Treasuries adhering to the Stability and Growth Pact to spend. The commission considers cyclically adjustments based on, among other things, unemployment minus the NAWRU. The Commission gives mere elected officials some slack if unemployment is above the NAWRU as estimated by Commission staff.

Unemployment is never far above the estimated NAWRU. The estimated NAWRU has dramatically increased in countries whose unemployment rates have increased. Estimates for Spain vary from 21% to 25%.

I think it is clear that there is something very wrong with the estimates. I think the approach has five fatal defects and should not be accepted as an area for further exploration let alone a basis for dictates to member countries. The first fatal defect of estimates of the NAWRU is that the hypothesis that there is such a thing has been rejected by the data. The concept survives only by changing the 1968 natural rate hypothesis into a natural rate model which is used without any assertion that it has testable implications which have not been rejected by the data.

The NAWRU is a meaningful concept only if the acceleration of wage inflation is a function of the unemployment rate. This might or might not be true. The logic was that wage settlements are made aiming for a real wage, so expected price inflation is incorporated one for one into wage inflation. It is assumed that all recognize that the nominal wage doesn't matter, so there is no particular problem with cutting nominal wages when expected price inflation is negative. The opinions on this question of everyone who has ever had any role in negotiating wages were considered irrelevant. The argument went on that people won't make forecasting mistakes with the same sign forever, so the coefficients of expected inflation on lagged inflation must add to one. Oh yes, it was assumed that expected inflation was a linear function of lagged inflation, because uh that makes the math easier. It was decided to cut out the middle periods and make the coefficient on once lagged inflation one. Finally, somehow, lagged wage inflation took the place of lagged price inflation (I can't even imagine a bad argument for this step, but the Commission took it).

The concept requires both that only the difference between nominal wage growth and expected inflation matter. This means that there is no downward nominal rigidity, that is there there is nothing special about nominal wage increases of zero nor any difference between wage inflation near zero and far from zero.

It also requires that expectations can not be anchored. Expectations which are sometimes anchored and sometimes not anchored are not a linear function of past outcomes. They are absolutely a feature of expectations elicited in experiments. When presented with random walks, people usually forecast mean reversion. However a series of increases in a row causes them to forecast further increases (Barberis, Nicholas, Andrei Shleifer, and Robert Vishny, 1998, A model of investor sentiment, Journal of Financial Economics 49, 307–343). This is a robust result.

If there is downward nominal rigidity or expectations can be anchored, then there may be no well defined NAWRU. This doesn't mean that it is impossible to calculate a number and call it the NAWRU. Rather it implies that there is a range of unemployment rates such that wage inflation does not accelerate. If that is the case, cyclical fluctuations of unemployment within that range will be incorrectly identified as fluctuations in the NAWRU. I think it is clear that, for Italy, this range stretches at least from 8% to 13%, since wage inflation has remained roughly constant as unemployment rose from 8% to over 13%. Wage inflation didn't increase back when Italian unemployment was 8% nor did it decrease after unemployment rose to over 13%.

The simple fact is that, in the 21st century, there is almost exactly precisely zero correlation between the Italian unemployment rate and the change in Italian wage inflation. To calculate a NAWRU year after year with such data requires heroic data processing.

Here is a Phillips scatter of unemployment and wages for Italy

Data from FRED. There is one observation per month from February 1980 through February 2015. Winf is the percent increase in LCWRIN01ITM661S the "Hourly Wage Rate: Industry for Italy©: Seasonally adjusted" over the preceding year (so the series for Winf consists of overlapping 12 month intervals). Unem is LRHUTTTTITM156S"Harmonized Unemployment: Total: All Persons for Italy©:Seasonally Adjusted" from January 1983 on but is ITAURHARMMDSMEI "Harmonized Unemployment Rate: All Persons for Italy© : Seasonally Adjusted" for 1980-1982. I have no idea why one series is available only after January 1983 or why the other is available only before August 2012 or how they differ (in the period when both are available, they are very similar but not identical).

I think it is obvious that the graph doesn't look as a Phillips curve should. Since January 2000, the unemployment rate has varied from 5.8% to 13.2 % yet wage inflation has varied only from 1.1% to 4.8%. 21st century changes in Italian wage inflation are dwarfed by the huge declines in the 1980s. According to the accelerationist Phillips curve, Italian wage inflation should have remained in double digits in the 80s and 90s or declined to well below zero by now.

It is possible to pick an arbitrary series of numbers and call them the highly variable NAWRU, that is, it is impossible to prove that no NAWRU exists (as it is impossible to prove a negative) but there is clearly no more evidence that Italy has a NAWRU than that it is haunted by ghosts.

Here is the graph for the 21st century

There is, perhaps, some hint of higher wage inflation at lower unemployment rates, but no clear acceleration. Nothing much seems to have happened to wage inflation as unemployment rose from around 8% to 13.2%.

The NAWRU refers to the acceleration of wage inflation. I consider the difference between wage inflation in one month and 12 months earlier (so it is an annual difference of an annual difference and the data refer to overlapping 24 month intervals)

This is an extremely impressively horizontal scatter. There is no sign of any association of unemployment and accelerating wage inflation at all. Here is a regression (with uncorrected standard errors)

. gen awinf = winf-winf[_n-12]

. reg awinf unem if month>2000

Number of obs = 181

F( 1, 179) = 0.00

Prob > F = 1.0000

R-squared = 0.0000

Adj R-squared = -0.0056

awinf | Coef. Std. Err. t

unem | 3.30e-07 .0396278 0.00

_cons | .0270689 .3569347 0.08

So "almost exactly precisely zero correlation " means a correlation coefficient of 0.00 something and a regression coefficient of 0.00000033 . The T-statistic is not correct, the standard errors should be corrected for the 24 periods of overlap. But I don't think that a T-statistic which is biased away from zero and equal to 0.00 really needs to be corrected. The almost exactly complete absence of any evidence of any effect of unemployment on the acceleration of wage inflation is extraordinary. It is extremely unlikely that two independent series would happen to have such low correlation.

This is the first regression I estimated with Italian data. Using the full sample I get a (statistically insignificantly) upward sloping accelerationist Phillips curve.

. reg awinf unem

awinf | Coef. Std. Err. t

unem | .0373827 .076396 0.49

_cons | -.8178216 .7054678 -1.16

I just now think that, maybe I should lead wage inflation acceleration (or lag unemployment)

awinf2 = winf[_n+12]-winf

. reg awinf2 unem if month>2000

awinf2 | Coef. Std. Err. t

unem | .0211333 .0482586 0.44

_cons | -.1483054 .4191373 -0.35

That doesn't make much difference does it ?

There is no hint in the Italian data that there is such a thing as a NAWRU. Those with firm faith can still believe in the NAWRU, but their faith receives no assistance at all from the data.

update: typos corrected thanks to Reason and Marco Fioramanti. An explanation was revised aiming for comprehensibility following advice from Marco Fioramanti.

Monday, December 21, 2015

NAWRU 1 The totally arbitrary estimated natural rate of unemployment and Euro Block Fiscal Policy.

Please read the version here which was updated and corrected (following comments by Marco Fioramanti)

European Commission fiscal dictates are based on outdated economic theory, strange econometrics and arbitrary ad hoc restrictions on parameter estimates. It is not easy to discuss the technique behind that which presents itself as technocracy with a straight face. The 'cracy part is genuinely powerful, so this matters.

This will be the first of a long long series of posts. It is written to blogging editorial standards, which means I think everything is true, but it's not as if I were submitting this to a peer reviewed Journal. I will try to present an outline.

A. Allowed deficits under the Stability and Growth Pact as revised in 2005 depend on estimated output gaps -- the restrictions on deficits refer to the "structural balance" (SB) which is the cyclically adjusted deficit minus one off expenditures and revenues. These posts will focus on the cyclical adjustment. The allowed deficit is 3% plus 0.5 times potential output minus actual output (the output gap). update: (correction due to Marco Fioramanti) Allowed spending depends on a "medium term objective" (MTO) which in turn is defined in terms of the SB end update. This means that estimation of potential output are very important as they is step required to apply an international treaty.

B. The European Commission (from now on EC) estimates of potential output are based on a production function and require estimates of the capital stock, total factor productivity and potential employment. This series of posts will consider only the estimates of potential employment. Potential employment is equal to the labour force times the natural employment rate. The natural employment rate is 100% minus the non wage inflation accelerating rate of unemployment (NAWRU). Estimates of the NAWRU are needed to construct estimates of potential output.

C. Another way of putting it is that the estimate output gap is a function of cyclical unemployment which equals actual unemployment minus the NAWRU. This means that estimates of the NAWRU are very important.

D. This means we (in the Eurozone) have a problem. The stability and growth pact requires estimation of the NAWRU which means that it dictates that there is a NAWRU and that, if unemployment is above the NAWRU the rate of increase of nominal wages declines. If the accelerationist Phillips curve does not correspond to reality, the Stability and Growth Pact is like the possibly mythical local ordinance which declared that Pi is equal to 3.0.

E This means that reassurances (to Paul Krugman) that policy makers and staff have moved on to use of Phillips curves with anchored expectations are uh not accurate.

F. There are many many problems with EC estimates of the NAWRU. This is obvious, because estimates of the NAWRU track actual unemployment and are absurdly high -- the EC estimate of the Spanish NAWRU for 2014 is greater than 20% (pdf warning) . I will write a post on each of the problems which I have noticed.

1. The theory which implies there is a NAWRU is rejected by the data. The acronym NAWRU implies that there is one and only one unemployment rate consistent with non accelerating inflation. European data from the past 7 years show huge fluctuations in unemployment and extremely stable inflation. There is no falsifiable hypothesis including a NAWRU which has not been falsified. The reaction has been to assume that the NAWRU fluctuates for unexplained reasons so the NAWRU story has no implications for the association between unemployment and inflation.

2. The changes in the NAWRU must be exogenous. It is not just that they are exogenous to the model (not explained) they must be unaffected by policy. This is an assumption. It is assumed that fiscal policy has no effect on the future NAWRU. In other words it is assumed that there is no hysteresis. This assumption is required for calculations of the effects of spending and revenues on the long term debt to GDP ratio (as stressed by DeLong and Summers pdf warning). The vitally important assumption is not tested.

3. The NAWRU is assumed to be an I(2) process -- not only does the level shift exogenously but so does the trend. This means that the first difference of the first difference of the NAWRU is stationary. This assumption implies that long term forecasts of the NAWRU, say 100 years from now, are always either greater than 100% or less than 0%. Clearly this is crazy. The original argument for an accelerationist Phillips curve is very explicitly an argument about the long run. There is a fundamental contradiction between the concept of a NAWRU and a time series model of the NAWRU whose long term implications are ignored.

4. The NAWRU is estimated by EC using two time series -- the acceleration of wage inflation and the unemployment rate. A model (explained for example in Fioramanti Padrini and Pollastri 2015 (warning same pdf to which I linked above). This model has 4 series of disturbance terms used to fit 2 time series. As one might guess, identification is a bit problematic. However, it is possible to convince a computer to estimate all the parameters.

5. In a last arbitrary ad hoc step, EC imposes limits on three of the parameters of their model. Crucially one of these is the variance of disturbances to cyclical unemployment. This last intervention is not motivated by theory or evidence. It has a very large effect on estimates of cyclical unemployment and allowed deficits.

I think it is clear that point 5 is very interesting. Even the reader who has been patient enough to read this far, might not be patient enough to read posts 1 through 4. I think 2, 3 and 4 will be skipable, but I don't guarantee that the future post 5 will be comprehensible without reading 1-4 (or even after reading 1-4).

update: the post has been corrected based on comments by Marco Fioramanti.

Friday, December 18, 2015

Kids these days

I am blogging with my smartphone while waiting for a plane. That is all.

Sunday, December 06, 2015

Is Okun's Law OK ?

I think this is the 4th thing I've written about this Krugman post "Anchors Away"* while alarmed by my obsession with that application of 1960s macro and 1960 (but not 61) macro to current issues, I do see some hope. I have made it to the last two paragraphs.

How much output growth would this involve? An Okun’s Law type relationship also works pretty well for the euro area as a whole, and gives a coefficient close to the US level:

[graph] So a 4 percentage point decline in unemployment would, if the historical relationship holds, mean 8 percent more in real GDP — that is, this naive calculation puts the euro area output gap at 8 percent, which is huge.

Should we take this seriously? If not, why not?

Glad you asked Paul. First I don't have a problem with the calculation that Euro block unemployment is 4% greater than it could and should be. The astonishing implication is that Euro block economies could endure unemployment as low as 6% without suffering ever rising inflation. I see no reason to doubt this. Even the famously dysfunctional Italian economy managed it (the stability of inflation is even more striking if one looks at wages not consumer prices -- the ups and downs of the consumer price inflation rate in the graph in the linked post correspond to sharp increases and decreases in the price of oil -- no new graph as this is not this post's topic).

But I am not so convinced by the Okun's law estimate and calculation. Krugman's estimate ( and Okun's) is a simple regression with no lags or leads. The regression is valid if unemployment is a function of current output so the immediate effect of a downturn is equal to the long run effect of a prolonged depression. However, in practice employment adjusts slowly in recessions with the peak of unemployment typically occurring after the trough of GDP. I think the coefficient of GDP growth on the change of unemployment reflects this slow adjustment of employment. I'd guess a long run Okun's relationship would give a number closer to labor's share so two thirds, maybe 1 but not 2. I won't estimate this coefficient using changes from 2007 to 2014 for different Euro group countries (although I should). It implies an output gap of roughly 3 to 4% which I find highly plausible.

I think this implies an average allowed deficit of 4.5 to 5% of GDP (IIRC the Eurocrats calculate that a 1% output gap causes the deficit to increase by 0.5% of GDP based on increased transfers as well as reduced tax revenues). *The pun in the title doesn't fit the content of the post and set a very bad example, which may have influenced me and led me aweigh from the balanced prose path appropriate for serious topics)

Phillips curve Philippic I

This post is a teaser. I am writing that I will be writing about how the Phillips curve is used by the European Commission and in particular EcoFin. I am trying to force myself to write something by promising the web that I will.

Just in general, when reflecting on the other than ideal state of academic macroeconomics, I have comforted myself with the thought that policy makers mostly ignore allegedly micro founded macro and, to the extent they listen to economists at all, use old pretty much Keynesian models roughly based on the work of Keynes Hicks, Solow Samuelson U Friedman and not of Lucas let alone Prescott (yes Friedman would be surprised to be called roughly Keynesian, but, in fact so called New Keynesian economics is largely based on Friedman as noted by Brad DeLong).

I am distressed because I have learned something from Marco Fioramanti about what models policy makers use. The model in question is a highly modified Phillips curve not a silly modern micro-founded macroeconomic model. It is used to estimate the non accelerating wage inflation rate of unemployment (NAWRU not exactly the same as the good old NAIRU because the inflation is wage inflation not price inflation). This is subtracted from unemployment to estimate cyclical unemployment. The estimated Cyclical unemployment is used to estimate potential output and the output gap (with a production function of capital and (employment + cyclical unemployment) and estimated technology (estimating technology is another very tricky issue). The output gap is used to cyclically adjust deficits -- that is to dictate fiscal policy.

The last part is key. At the end of the calculations there aren't recommendations to policy makers. The calculations are part of implementing an international treaty -- the Stability and Growth Pact as modified in 2005.

In order to ensure long-term compliance with the SGP deficit and debt criteria, the member states have since the SGP-reform in March 2005 striven towards achieving their country-specific Medium-Term budgetary Objective (MTO). The MTO is the set limit, that the structural balance relative to GDP needs to equal or be above for each year in the medium-term. Each state select its own MTO, but it needs to equal or be better than a calculated minimum requirement (Minimum MTO) ensuring sustainability of the government accounts throughout the long-term (calculated on basis of both future potential GDP growth, future cost of government debt, and future increases in age-related costs). The structural balance is calculated by the European Commission as the cyclically-adjusted balance minus "one-off measures" (i.e. one-off payments due to reforming a pension scheme). The cyclically-adjusted balance is calculated by adjusting the achieved general government balance (in % of GDP) compared to each years relative economic growth position in the business cycle (referred to as the "output gap"), which is found by subtraction of the achieved GDP growth with the potential GDP growth. So if a year is recorded with average GDP growth in the business cycle (equal to the potential GDP growth rate), the output gap will then be zero, meaning that the "cyclically-adjusted balance" then will be equal to the "government budget balance". In this way, because it is resistant to GDP growth changes, the structural balance is considered to be neutral and comparable across an entire business cycle (including both recession years and "overheated years"), making it perfect to be used consistently as a medium-term budgetary objective.[24][25]

Whenever a country does not reach its MTO, it is required in the subsequent year(s) to implement annual improvements for its structural balance equal to minimum 0.5% of GDP, although it should be noted that several sub-rules (including the "expenditure benchmark") has the potential slightly to alter this requirement.

As a "pact" this can't be unilaterally changed by a national parliament. Here is an extreme (but not misleading) edit ""output gap" ... a country ... is required". The calculated output gap affects what once sovereign countries are required to do.

However, the output gap has to be estimated by a long suffering staff which has to follow clear objective unchanging rules (they not being superior to elected officials as their immediate superiors are). These rules have to make sense and yield sensible results even if the economic model on which they are based doesn't fit recent data well. Since casual discussion of the Stability and Growth pact doesn't clearly distinguish the structural deficit and the ordinary budgetary deficit, large cyclical adjustments would cause extreme suspicion that the rules were being bent.

In particular, that which many countries are required to do depends on a calculation based on an accelerationist Phillips curve. Behind the calculation there is a model in which it is assumed that unemployment affects the change in the rate of wage inflation and in which a decrease from 11% to 9% is just like a decrease from 1% to -1%. This means that, to the extent that the Stability and Growth Pact is involved, policy is absolutely not based on consideration of Phillips curves with anchored expectations.

The reassuring claims about policy and Phillips curves made to Paul Krugman -- " the usual response from model-oriented public officials and research staff at policy institutions is to say that what they work with now is a Phillips curve with “anchored” expectations " -- are to this important extent, false.

Krugman calculated a Euro area output gap using an anchored Phillips curve. Even he is astounded (and unconvinced) by his calculated output gap of 8%. Using such a gap for the correction would allow a fundamental transformation of fiscal policy in many Euro area countries. These do not including those, such as Germany, where the pact isn't binding, or Greece which can't borrow even if it had EcoFin permission, because no one will lend to them. However, they most definitely include Italy.

I don't take Krugman's calculation more seriously than he does (another post) but it is easy to understand why the binding authoritative calculations with the force of an international treaty are completely different. One reason is that they are based on an accelarationist Phillips curve estimates of which imply double digit natural rates of unemployment (which have shot up since 2008). The other (and probably more important) explanation is that such a conclusion is unacceptable to the Eurocrats who claim to be technicians not dictators, but who accept no limits on their power and will never accept markedly higher deficits.

Still the demonstrable fact that the official and binding calculations are based on a model which is wildly at odds with the data might have some impact on someone somewhere sometime somehow.

Saturday, December 05, 2015

Donald Trump number one in all the polls

of course that is in @Satan 's time line. I would guess Donald Trump is less hated by people who follow @realDonaldTrump but I'd rather go to hell than go there.