Estimating the Structural Balance: European Commission versus Domestic Forecasts
This post was written by Philip Lane
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.