Blog Post

The structural budget balance limbo

A key indicator in the EU’s fiscal framework is the structural budget balance, but estimates of the indicator by the European Commission, IMF and OECD are revised a lot from one year to the next, sparking concerns among some EU finance ministers.

By: Date: April 7, 2016 Topic: European Macroeconomics & Governance

Recently, the finance ministers of eight euro-area countries expressed doubts about EU methods for estimating the cyclical position of the economy (the so-called ‘output gap’). They worry about its implication for EU fiscal rules.

In my view, the concerns of these ministers are justified.  In this post I illustrate the uncertainty in estimations of the so-called structural budget balance, which is a key fiscal indicator in the EU’s fiscal framework. I compare the estimates of the European Commission, IMF and OECD.

The structural balance of the government, an unobserved variable, aims to measure the ‘underlying’ position of the budget by excluding the impacts of temporary effects: the economic cycle and one-off measures.

In a recession, tax revenues are smaller and unemployment benefit expenditures are larger. However, once the economy returns to its potential level of output, both tax revenues and unemployment benefit expenditures return to normal.

Likewise, in a given year, one-off budgetary measures, such as bank bail-outs, can make the actual deficit larger. Or a temporary tax can bring revenues that make the budget position look better.

Excluding the impacts of these temporary factors from the annual budget balance to estimate the structural balance is therefore conceptually intuitive. The problem is that these estimations are really uncertain. A key source of error is related to errors in the estimation of the output gap. I analysed this issue here, using the revision of the initial estimate one-year later. In this post I use the same measure to analyse the revisions in structural balance estimates from the European Commission, IMF and OECD.

Figure 1 indicates major revisions. It also indicates that revisions by the three institutions are broadly similar, underlining the inherent difficulties in estimating structural budget balances.

Figure 1: Three measures of structural balance estimate revisions (% of potential GDP, absolute value)

Note: unweighted country averages of the absolute value of revisions (as % of potential GDP) are reported. Due to unavailability of some earlier European Commission and OECD structural balance estimates, the revision in the cyclically adjusted budget balance is reported for the first three years for the Commission estimates and for the first six years for the OECD estimates.

ZD-7-04-2016

The first chart in both blocks shows the “revision of previous year estimate one year later”. For example, the final data point is the difference between the estimates for 2013 published in spring 2015 and spring 2014. These spring estimates are typically published by the IMF in April, by the European Commission in May and by the OECD in June, when budget data for the previous year is known with a reasonable precision. Despite that, estimates for the last year structural balances are revised quite significantly. These revisions are about 0.3-1.0 percent of GDP in ‘normal’ years, while in ‘crisis’ years revisions are much larger.

The second chart in both blocks shows the “revision of current year estimate one year later”. For example, the final data point is the difference between the spring 2015 and spring 2014 estimates for 2014. Since, for example, the spring 2014 estimate for 2014 involves forecasts, it is not surprising than revisions are larger than the revisions of the estimates for the previous year.

The third chart in both blocks shows the “revision of the change from previous year to current estimate one year later”. For example, the final data point is the difference between spring 2015 and spring 2014 estimates of the change in the structural balance from 2013 to 2014. There are major revisions in this indicator too, which are typically between 0.5-1.0 percent of GDP, while in ‘crisis’ years revisions are again much larger.

What does this mean looking ahead? Let us say, for example, that the Commission forecasts in May 2016 that a country’s structural balance will remain unchanged from 2015 to 2016. Then, in May 2017, when new estimates are published, it is likely that the Commission will estimate the 2015-2016 change in the structural balance to have been half a percent of GDP or larger (either an increase or decrease).

Half a percent of GDP is the usual adjustment requirement under the EU fiscal rules. I find it unacceptable that the EU’s fiscal framework strongly relies on an indicator (the change in the structural balance) for which the typical one-year revision in the estimate is larger than the required policy action.

Moreover, the figure above indicates revisions just one year later. Longer-term revisions (e.g. the difference between the 2015 and 2010 estimates for 2010) are even larger.

Revision of an estimate when new data becomes available is quite natural. Also, in some years the methodologies used to estimate potential output and the structural balance were revised. It is better to revise an initial estimate when it turns out later that it was incorrect than to continue using an incorrect estimate. But the problem is that the EU fiscal framework specifies short-term numerical targets for both the level and the change in the structural budget balance. Therefore, imprecision in the estimates can translate into fiscal policy decisions.

This imprecision in estimates of the structural balance was a key reason why, in a recent policy contribution with Gregory Claeys and Álvaro Leandro , we suggested that the EU should eliminate fiscal rules related to the structural balance. We propose a better fiscal rule, explained in detail in the policy contribution.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article Download PDF
 

Policy Brief

Rebooting Europe: a framework for a post COVID-19 economic recovery

COVID-19 has triggered a severe recession and policymakers in European Union countries are providing generous, largely indiscriminate, support to companies. As the recession gets deeper, a more comprehensive strategy is needed. This should be based on four principles: viability of supported entities, fairness, achieving societal goals, and giving society a share in future profits. The effort should be structured around equity and recovery funds with borrowing at EU level.

By: Julia Anderson, Simone Tagliapietra and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance Date: May 13, 2020
Read article More on this topic More by this author
 

Opinion

The message in the ruling

The German Constitutional Court's ruling on the ECB's asset purchase programme is open to much criticism but it can hardly be blamed for raising an important question.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: May 12, 2020
Read article More on this topic More by this author
 

Blog Post

COVID-19: The self-employed are hardest hit and least supported

Self-employed workers are hardest-hit by COVID-19 lockdowns. Yet they often receive less government support than salaried employees. Is the disparity justified?

By: Julia Anderson Topic: European Macroeconomics & Governance Date: April 8, 2020
Read article More on this topic
 

Opinion

A European approach to fund the coronavirus cost is in the interest of all

We had not seen a common challenge as clear as this pandemic. The sum of national actions and programs is likely to be insufficient.

By: Agnès Bénassy-Quéré, Arnoud Boot, Elena Carletti, Jan Krahnen, Miguel Otero-Iglesias, Lucrezia Reichlin, Dirk Schoenmaker and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: April 6, 2020
Read article More on this topic More by this author
 

Opinion

A temporary, common fiscal stimulus to answer the mayhem of COVID-19

We are not in normal times and we have to surpass, albeit only for the duration of the COVID-19 shock, the hurdles that did not allow the euro-area to endow itself of a common fiscal policy.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: April 2, 2020
Read article More on this topic More by this author
 

Opinion

Will the economic strategy work?

Because even thriving companies can be killed in a matter of weeks by a recession of the magnitude now confronting the world, advanced-economy governments have reacted in a remarkably similar fashion to the COVID-19 crisis. But extending liquidity lifelines to private businesses and supporting idled workers assumes a short crisis.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: April 1, 2020
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: The macroeconomic policy response to the COVID-19 crisis

Which macroeconomic policy response is the best option to deal with the crisis currently unfolding and will ensure that the recovery will be as quick as possible?

Speakers: Grégory Claeys, Giuseppe Porcaro, Lucrezia Reichlin and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: March 31, 2020
Read article More on this topic More by this author
 

Blog Post

The fiscal consequences of the pandemic

The likely economic depression triggered by coronavirus will pose a serious fiscal challenge to some euro-area countries. Given the special circumstances of the pandemic, a European solution is needed, involving more European Central Bank purchases, a significantly increased European Stability Mechanism and some degree of mutualisation of the pandemic-related economic costs.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: March 30, 2020
Read article
 

Blog Post

COVID-19 Fiscal response: What are the options for the EU Council?

It is time for the EU Council to make quick progress on the fiscal front and announce something as soon as possible to show that it taken full measure of the severity of the situation.

By: Grégory Claeys and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: March 26, 2020
Read article More on this topic
 

Blog Post

Coronavirus and the politics of a common fiscal instrument

Coronavirus means many European Union countries will soon face major increases in their sovereign debt burdens, exacerbated by the sudden collapse of economic activity. What should the European Union do to address these debt problems?

By: Mark Hallerberg and Stavros Zenios Topic: European Macroeconomics & Governance Date: March 25, 2020
Read article More on this topic More by this author
 

Blog Post

What should be done to reduce euro-area spreads?

Spreads are rising again in the euro-area at the worst possible time, when fiscal policy is needed to fight the coronavirus pandemic and the related economic shock. This blog post reviews the main options available to European policymakers, their feasibility and potential effectiveness to deal with this issue.

By: Grégory Claeys Topic: European Macroeconomics & Governance Date: March 18, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

How can the EU prevent our economies from shutting down?

From flights cancelled and restaurants closed to companies either slowing or stopping their production, COVID-19 is shutting our economies down. How can the EU reboot them? What should be our fiscal and monetary response to the pandemic? Will our economic system ever be the same once everything is over? This week, Guntram Wolff is joined by Jean Pisani-Ferry and Maria Demertzis to discuss the EU's response to the coronavirus.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: March 18, 2020
Load more posts