Euro Zone Crisis: EU tentatively approve change in the method to calculate structural deficits of its members

In an article published today in the Wall Street Journal the issue is the change in the methology
used by the EU for estimating the structural deficits of its members:
"European finance officials have tentatively approved a change to the region's budget policies that is likely to lighten the austerity required of Spain and other countries hardest-hit by the sovereign-debt crisis.

Spain and others argue that their deficits have been inflated mainly by the economic crisis, not by lax government spending and low taxes.

In a weak economy, with mass unemployment and many factories running at only a fraction of full capacity, government revenue is depressed and social spending is elevated".

The structural deficit in these circumstances will be lower than the actual deficit, representing the assumption that once the economy strengthens, the real deficit will naturally narrow, without cuts to government spending or tax increases that have proved politically toxic.

But Europe's current method for calculating the structural deficit has determined that much of the budget deficits seen in the bloc's weakest economies are structural, or built-in, not cyclical. That means they will persist even after the economy has returned to full strength. So austerity measures—spending cuts or higher taxes—are required.

The calculation is based on the commission's finding that even some of the bloc's weakest economies are operating relatively close to full capacity, which many of those countries dispute. They argue that the difference between the current state of the economy and full capacity is significantly larger than the commission's estimates.

The commission believes that the "natural" rate of unemployment—if the Spanish economy were operating at full potential—is 23%

The new methodology will lower estimates of the "natural" unemployment rate for crisis-hit countries, meaning that it will need to drop sharply for the economy to be considered operating at full potential.