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The Role of Endogenous NAWRU in Reducing the "Space of Forgiveness": a Theoretical and Empirical Appraisal of the European Fiscal Framework

Author

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  • Giovanni Carnazza
  • Emilio Carnevali
  • Matteo Sommacal

Abstract

The European Union's fiscal policy framework imposes constraints on individual countries' fiscal policies to ensure long-term financial sustainability. However, it is also designed to provide flexibility through the operation of "off-balance" automatic stabilisers. In practice, these rules have led to pro-cyclical measures in EU peripheral countries due to the way European institutions estimate the Non-Accelerating Wage Rate of Unemployment (NAWRU). The paper demonstrates the pro-cyclical nature of the current mechanism by combining empirical evidence covering the period 2002-2023 with a semi-analytical model of the potential output and NAWRU dynamics to estimate the change in the Cyclical Component due to the endogenisation of the variables relevant to the business cycle. Since the recent reform of the Stability and Growth Pact has maintained the core of this mechanism, the challenges identified for the period 2002-2023 are likely to persist in the upcoming years as well.

Suggested Citation

  • Giovanni Carnazza & Emilio Carnevali & Matteo Sommacal, 2024. "The Role of Endogenous NAWRU in Reducing the "Space of Forgiveness": a Theoretical and Empirical Appraisal of the European Fiscal Framework," Discussion Papers 2024/316, Dipartimento di Economia e Management (DEM), University of Pisa, Pisa, Italy.
    • Handle: RePEc:pie:dsedps:2024/316
    Note: ISSN 2039-1854
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    File URL: https://www.ec.unipi.it/documents/Ricerca/papers/2024-316.pdf
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    References listed on IDEAS

    as
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    4. Julia Lendvai & Matteo Salto & Anna Thum-Thysen, 2015. "Structural unemployment vs. NAWRU: implications for the assessment of the cyclical position and the fiscal stance," European Economy - Economic Papers 2008 - 2015 552, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    5. Gootjes, Bram & de Haan, Jakob, 2022. "Procyclicality of fiscal policy in European Union countries," Journal of International Money and Finance, Elsevier, vol. 120(C).
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    More about this item

    Keywords

    National Budget; Aggregate Production Function; Fiscal Policy;
    All these keywords.

    JEL classification:

    • H61 - Public Economics - - National Budget, Deficit, and Debt - - - Budget; Budget Systems
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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