Potential output measurement and structural unemployment (NAWRU) in the context of the European Union

The potential output of an economy is a key concept in the context of the EU fiscal regulation, as its estimation is used to calculate the “structural” budget balances that determine the specific fiscal policy directions of individual countries. After providing an overview of the methodologies adopted in the context of the European institutions to estimate potential output, we discuss different meanings and interpretations of the concept, which reflect different theoretical standpoints. We highlight some problems related to the mainstream explanation and the paradoxical outcome that the estimated value for the theoretical magnitude, the one that should act as an attractor for the realized one, ends up being determined, mostly, by the realized, effective variable. Finally, we elaborate on the policy implications within the EU regulatory framework that ensue from the previously discussed issues, such as the prescription of restrictive fiscal policies, to comply with European fiscal rules, even in recessions.