Estimating the Structural Balance: European Commission versus Domestic Forecasts

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A recurring question in the treaty debate is whether each country must accept the European Commission’s own estimate of the output gap and the structural component of the budget balance.  For some countries, it may be fine to just take the European Commission’s estimates.  However, this is not a requirement under the evolving economic/fiscal governance reforms (by the way, this is a handy summary page of the set of inter-linked regulations etc).

The “six pack” Council Directive 2011/85/EU of 8 November 2011 on requirements for budgetary frameworks of the Member States (available here) has the following sections

(11) Forecasts by the Commission and information regarding the models on which they are based can provide Member States with a useful benchmark for their most likely macrofiscal scenario, enhancing the validity of the forecasts used for budgetary planning. However, the extent to which Member States can be expected to compare the forecasts used for budgetary planning with the Commission’s forecasts varies according to the timing of forecast preparation and the comparability of the forecast methodologies and assumptions. Forecasts from other independent bodies can also provide useful benchmarks.

(12) Significant differences between the chosen macrofiscal scenario and the Commission’s forecast should be described and reasons therefore should be given, in particular if the level or growth of variables in external assumptions departs significantly from the values contained in the Commission’s forecasts.

(13) Given the interdependence between Member States’ budgets and the Union’s budget, in order to support Member States in preparing their budgetary forecasts, the Commission should provide forecasts for the Union’s expenditure based on the level of expenditure programmed within the multiannual financial framework.

(14) In order to facilitate the production of the forecasts used for budgetary planning and to clarify differences between the forecasts of the Member States and those of the Commission, each Member State should, on an annual basis, have the opportunity to discuss with the Commission the assumptions underpinning the prep­ aration of macroeconomic and budgetary forecasts.

(15) The quality of official macroeconomic and budgetary forecasts is critically enhanced by regular, unbiased and comprehensive evaluation based on objective criteria. Thorough evaluation includes scrutiny of the economic assumptions, comparison with forecasts prepared by other institutions, and evaluation of past forecast performance.

In addition, the European Commission has elaborated on how it envisages the monitoring and correction process will operate  – importantly, it does allow for a role for domestic independent forecasts.  From its proposed “two pack”  regulation (November 23 2011)

Article 5.3 (e)
(e)  the main assumptions about expected economic developments and important economic variables which are relevant to the achievement of the budgetary targets. These assumptions shall be based on independent macroeconomic growth forecast;

where Article 2.1.2 provides the definition

“independent macroeconomic forecasts” means the macroeconomic and/or budgetary forecasts produced by an independent body or a body endowed with functional autonomy vis-à-vis the fiscal authorities of the Member State;

So, my understanding is that credible, independent domestic forecasts can be used as an alternative to the European Commission forecasts.  This requires Ireland to build the local capacity to produce such estimates, using models that can rival (or demonstrably improve upon) the European Commission model.

A related point is that the European Commission’s resources for macroeconomic forecasting are quite limited. A major advantage of domestic fiscal frameworks is that the primary responsibility for holding governments to account is local, with the political system supported by analysis and forecasting from independent domestic institutions that have the expertise and (modest) resources required to build tailored models of the domestic economy and domestic fiscal system.

19 Responses to “Estimating the Structural Balance: European Commission versus Domestic Forecasts”

  1. The Dork of Cork Says:

    I really don’t see the point of fiscal concerns in this monetory envoirment , the ratios of bank credit to fiscal debt are just too high to reverse via deflationary policies.
    We have had deflation in Europe since the early 80s – as soon as the debt grew to large amounts………..what is more deflation going to do for us ?

    A renationalisation of the countries monetory systems via massive interest free base money printing is the only option.

    We must recognize Europe was a trap from the beginning , first they came for the small farmers…………

    This deferring of rational capital expenditure to service rentier interest seeking units & actors has run its course – theres very little capital remaining to extract – its all extracted out I am afraid.

  2. The Dork of Cork Says:

    Is the neoclassical citadel slowly being broken down by a rag tag mixture of various neo – Keynesian’s , MMTers & Austrians ?

    The Steve Keen vs Krugman bitch fight is certainly entertaining.
    http://www.youtube.com/watch?v=iWEq27Ai6ZU

    But why do neoclassical economists essentially ignore bank credit in their models ? , its a bit like economists of the 19th century that ignore the role of free banks in their world view – very strange stuff.
    Theres not much difference between Bank notes created in the commercial banks vault & bank credit via double accounting – they both inflate asset prices to extreme levels.
    The banks don’t even accept that M1 must be the monetory base..even stranger.
    Also what do you make of Scot Fullwiler take on Krugmans very linear world view of economics as it is translated into the financial world.
    He a trade economics guy (krugman) – is he not – he seems way out of his depth this Krugman.
    Would like to see both of them square off on some show although I guess Krugman would only fight on his home ground
    The Charlie Rose show or some such.

    This is very complex stuff and beyond my pay grade but it is a beautiful expression of simplicity when compared to how the Euro banking system operates.
    The MMTers don’t even go there.

    How can something so complex (the euro) be made to function with any degree of reliability or indeed trust ?
    I certainly don’t trust it now – it not a token of something but a yield instrument for the US $ me thinks.

    Its a expression of pure evil.

  3. The Dork of Cork Says:

    Sorry if I am being a bit obtuse but my point is why should goverments only money power be the ability to tax bank credit creation ?

    As that seems to be the end game in town for the euro boys.

    The credit banks can create any asset (loan) or liability (deposit) fluff they like.
    As long as there is increasing natural resourses to pull out of the ground it appears we have growth through increased consumption of this fluff – goverments can be as fiscally responsible as they like such as the Irish & Spanish were (silly dears) but if they tax fluff……… – what then ?
    POP >>>>> BUST———————collapse

    My point is bank credit is all about wasting a surplus………it does not create anything on a net basis.
    You need money production to produce the commons…… then it can be destroyed via credit.
    The Banksters have got it all wrong or are more likely just plain evil.
    The French state via the Rothschilds built Nuclear reactors – after the power is on line you can then produce bank credit to waste the power by buying washing machines , hair dryers and such.
    Producing bank credit and then taxing a smaller & smaller wealth base over time is a obvious cul de sac.
    A debt end.

  4. Bryan G Says:

    @Philip Lane

    So, my understanding is that credible, independent domestic forecasts can be used as an alternative to the European Commission forecasts.

    I disagree. The provisions you quote (from the Directive on budgetary frameworks and the proposed 2-pack legislation) have a broader, and less authoritative, scope than the actual Regulation covering the MTO itself (1175/2011), which takes precedence, and which says

    The reference medium-term rate of potential GDP growth should be calculated according to a commonly agreed method. The Commission should make public the calculation method for those projections and the resulting reference medium-term rate of potential GDP growth.

    and

    The reference medium-term rate of potential GDP growth shall be determined on the basis of forward-looking projections and backward-looking estimates. Projections shall be updated at regular intervals. The Commission shall make public the calculation method for those projections and the resulting reference medium-term rate of potential GDP growth.

    As I understand it the rate of potential GDP growth is a key parameter in determining the output gap and thus the position in the economic cycle, and thus the level of the structural balance. The Regulation shows that this is a Commission responsibility, and that they must make public all the calculations they use.

  5. PR Guy Says:

    @The Dork of Cork

    “Producing bank credit and then taxing a smaller & smaller wealth base over time is a obvious cul de sac. A debt end.”

    +1 (and an excellent play on words too!)

    @Philip Lane

    “A major advantage of domestic fiscal frameworks is that the primary responsibility for holding governments to account is local”

    But is that the grand EU plan going forward?

  6. Eureka Says:

    ….and Europe drifts ever further from the people.
    This is a recipe for very unsavoury haggling in years to come.

  7. Philip Lane Says:

    @ Bryan G

    What you cite explains the process by which the Commission forecasts should be made and states that the Commission forecasts are the ‘reference’ forecasts. This is consistent – a country can only depart from the ‘reference’ forecast if it has a credible, independent source for its alternative forecast.

  8. Brian Woods Snr Says:

    @ Dork: “A debt end.”

    Nifty!

  9. Bryan G Says:

    @Philip Lane

    The Regulation that defines the medium term objective defines it in terms of the reference rate of potential GDP growth, and does not provide for national authorities to substitute their own values for this parameter. The 3% GDP deficit limit is also called a “reference” rate.

    The Directive (which has a lower legal standing) that you quote refers to a much broader set of forecasts, to be used to support compliance with the core “reference” rates such as the 3% deficit limit and the MTO.

    For example, currently the Commission have set a target deficit limit each year up to 2015 for Ireland (e.g. 8.6 -> 7.5 -> 5.0 -> 2.9). Then a series of forecasts on growth, revenue and expenditure are made by the DoF (and Commission) to determine the size of the budget adjustment needed each year. It is these forecasts where alternatives can be used, but the core reference target and the trajectory to it are determined by the Commission. Similarly, in my view, the Commission will set the MTO and the adjustment path to it, and also the potential GDP reference rate used to determine the position in the economic cycle. As with the procedures needed for compliance with the 3% reference rate, a set of forecasts will be needed to determine the actual budget adjustments needed each year for MTO compliance. The Commission will not micromanage each individual forecast on future revenues and expenditures, for example, but will want to keep control over the higher level “reference” targets and trajectories, just as they do for the 3% limit.

  10. Gavin Kostick Says:

    @ Philp Lane, Bryan G

    At the risk of making a fool of myself.

    What the Irish people are being asked to vote on is the Fiscal Compact. I link the text I’m looking at below.

    My understanding is that this is an intergovernmental treaty, not an EU one. It is a stand-alone. The intention is to make it part of the EU system somehow, but this has not happened and some are arguing it cannot happen. I am assuming that this will not have happened by the end of May in any case. Therefore it is a ‘what it says on the tin’ compact.

    It is all a bit tricky though, because both in the preamble and in the agreement it refers to the revised Stability and Growth Pact and The Treaty on the Functioning of the European Union.

    This is one of those rare posts where I’ve changed my mind a bit while looking at it.

    The beginning of Article 8 says:

    “The European Commission is invited to present in due time to the Contracting Parties a report on the provisions adopted by each of them in compliance with Article 3(2). If the European Commission, after having given the Contracting Party concerned the opportunity to submit its observations, concludes in its report that a Contracting Party has failed to comply with Article 3(2), the matter will be brought to the Court of Justice of the European Union by one or more of the Contracting Parties.”

    Article 3(2) says:

    “2. The rules mentioned under paragraph 1 shall take effect in the national law of the Contracting Parties at the latest one year after the entry into force of this Treaty through provisions of binding force and permanent character, preferably constitutional, or otherwise guaranteed to be fully respected and adhered to throughout the national budgetary processes. The Contracting Parties shall put in place at national level the correction mechanism mentioned in paragraph 1.e) on the basis of common principles to be proposed by the European Commission, concerning in particular the nature, the size and the time-frame of the corrective action to be undertaken, also in the case of exceptional circumstances, and the role and independence of the institutions responsible at national level for monitoring the observance of the rules. This mechanism shall fully respect the prerogatives of national Parliaments.”

    And article 1.e says:

    “e) In the event of significant observed deviations from the medium-term objective or the adjustment path towards it, a correction mechanism shall be triggered automatically. The mechanism shall include the obligation of the Contracting Party concerned to implement measures to correct the deviations over a defined period of time.”

    So, hypethically now, were the Fiscal Compact to go through, I think Ireland would be in a stronger position if it had an independent body looking at the structural deficit to present to the Commission, particularly in the nasty event of being hauled into Court, where Ireland could show “the role and independence of the institutions responsible at national level for monitoring the observance of the rules.”

    Having said that though, I can feel my brain being captured and I remind myself of Shay Begorragh’s excellent summary here at 1.20am:

    http://www.irisheconomy.ie/index.php/2012/04/04/the-tscg-and-irish-fiscal-policy/#comments

    http://www.european-council.europa.eu/media/579087/treaty.pdf

    http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:0047:0200:en:PDF

  11. paul quigley Says:

    The ‘Irish ‘economy is a Hall of Mirrors:

    ‘As the graphic illustrates, Irish export growth of 4 per cent in 2011 put it in 21st place among the EU 27, well below the EU average growth rate of over 6 per cent. But this headline figure masks a difference in performance between services exporters and their goods-making counterparts.

    Irish exports are extremely unusual in that almost half are accounted for by services (one-fifth is a more normal share for a developed economy). Last year Ireland’s comparative position in services exports was good, with annual growth of 5 per cent, exceeding the EU average of 4 per cent.

    Goods exports, by contrast, did less well. A growth rate of just 3.4 per cent was half the average, putting Ireland in 25th position among the EU 27
    …….Finally, when measured by the contribution of net exports – exports minus imports – to economic growth, Ireland was much higher up the EU league table.
    But that was because Ireland was one of only five EU 27 countries to record a fall in imports last year. A quirk of national accounting means that a fall in imports causes GDP to rise, even if falling imports is not necessarily a good thing’

    http://www.irishtimes.com/newspaper/finance/2012/0406/1224314438685.html

  12. paul quigley Says:

    Sorry that last post in wrong thread.

  13. The Dork of Cork Says:

    @Paul
    What was the domestic demand of the Baltics ?
    I am not big into Maoist export drives to pay off malinvested Swedish debt to be honest.

    What I have read about the Baltics is that their societies have effectivally imploded.
    Their generally stoic nature masks the damage done to these places – with the old remaining while the young have left the building.
    I remember having a conversation with a beautiful lithuanian / Russian ? girl during the boom – she said her town was devastated (Visaginas ?) by the nuclear shutdown programme.
    I don’t believe in this Europe , its a rentiers paradise – its time to re nationalise our monetory systems and rebuild the real capital base.
    That will involve substantially reducing our import dependency as it opens us up to external financial shocks.

  14. Brian Woods Snr Says:

    @ Dork: Had a brief, 30 sec conversation with Int Relations expert.

    Me: This new EU guff about Free Trade agreements and Investment in developing nations? This is a New, New Realism? New, New IMF, Washington Consensus sort of stuff?

    PS: Yes.

    Me: The principal agents are no longer Sovereigns, but MNCs (including financials, and especially food conglomerates) who have coercively enrolled Sovereigns as their protectors, debt collectors and enforcers? They have externalized these ‘costs’.

    PS: That’s about it.

    History rhymes!

  15. The Dork of Cork Says:

    @Brian
    This is a extreme form of corporate fascism – the money power has been completly taken out of our hands.
    Free trade destoys internal domestic economies – 19th century America was not built on free trade !
    The only tax back then was excise duties was it not ?

  16. Brian Woods Snr Says:

    @Dork: Yeah, folk have short memories – and very lopsided belief systems.

    Few folk know about, hence cannot understand, the manner in which modern, cross-national business (trades in goods, services and virtual money) is conducted.

    When you attempt to explain it, they are so shocked that they simply disbelieve you. So monstrous a scheme could not be possible. Trouble is, it is. And it is in rude good health.

    What will it take to get Paddy and Maire onto the streets with pots, pans and flares? Whatever it is, no one will have seen it coming! 8-)

  17. Shay Begorrah Says:

    @Gavin Kostick

    So, hypothetically now, were the Fiscal Compact to go through, I think Ireland would be in a stronger position if it had an independent body looking at the structural deficit to present to the Commission, particularly in the nasty event of being hauled into Court, where Ireland could show “the role and independence of the institutions responsible at national level for monitoring the observance of the rules.”

    I hate to be so relentlessly negative but I think every part of the Fiscal Compact is either a distraction, a Christian Democrat dog whistle or a weight on popular democracy.

    Firstly the idea of an “independent body” advising government bothers me somewhat – if the body is selected from a small pool of experts considered politically sensible then we have an arm of government that is conservative in intent and that inevitably drags politics to the right, the unemployed will get the blame and not tax avoidance. There should not be parts of the executive parts of government in that are independent of popular democracy – the judiciary are independent but do not get to influence legislation and conversely the economic part of government policy making should not be allowed to get the impression they owe allegiance to some higher economic purpose (“for price stability, budget surplus and market discipline!”).

    However something along the lines of the US’s Congressional Budget Office which gives parliamentarians a way of comparing budgetary outcomes seems like a very good idea, substantially because it only does projections and is hence less prone to ideological taint and also that it allows the machinery of the state to support the operation of parliamentary democracy which we badly need.

    A second problem with the idea of budgetary policy being beholden to “independent ” bodies, in Ireland or the EU, is that it gives further solace and support to those pushing fiscalizaton (see Krugman here) as the root of the Eurozone crisis. Of course the current problems are a component of a larger global financial crisis which has made much worse by the implementation of EMU and EU trade balances but that suits the currently dominant voices in Europe not at all. Fiscalization is the enemy of progressive politics and of any idea of a people’s EU and needs to be opposed wherever it raises its head – the idea of making a dubious political analysis part of the law in every Eurozone country is a shocking indictment of where the EU is today.

  18. Bryan G Says:

    @Gavin Kostick

    The Medium Term Objective target (and its use of a reference value of potential GDP growth rate) is specified in an EU Regulation. EU-law has primacy over national law, so the
    provisions of a regulation apply, no matter what is put into national legislation (whether domestically initiated or added as a result of the transposition of a Directive). Also this regulation, being part of the SGP, will apply whether or not the Fiscal Compact treaty is adopted.

    There is clearly a benefit (in fact I would say it is essential) to having a strong analytical domestic capability in order to be able to influence EU policy in this matter. However in my view, based on what the regulation actually says, the decision maker as regards determining the position in the economic cycle is the EU Commission. Ireland has, as every country does, two representatives on the Output Gap Working Group. Perhaps they could be tracked down to see what their views are.

    More generally there is a lack of appreciation about how many aspects of budgetary policy have already been delegated to the EU, or at least, outside the government. For example Ireland has already agreed that all growth forecasts should be made by an “independent” body, so the fact that the DoF keep getting it wrong will shortly be just a historical footnote – they won’t be doing the forecasts that matter. Ireland has also agreed that the Commission can examine all budgets before adoption and adopt opinions on them, and suggest amendments during the course of the year. And also agreed a “commitment to stick to the recommendations of the Commission and the relevant Commissioner regarding the implementation of the Stability and Growth Pact.” And agreed that any major reform plans should be discussed in advance with other Member States. And on it goes. All these commitments will still apply even after exiting from the IMF-EU programme.

  19. Gavin Kostick Says:

    @ Shay Begorrah and Bryan G

    Thanks for those.

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