Structural versus nominal deficits

Fiscal sustainability is a necessary condition for economies to function.
The conditions for sustainability are objective. For example, the difference between the rate of income growth and the interest rate on sovereign debt, and/or the path of fiscal deficits/surpluses, determine if the fiscal stance is sustainable (meaning that the inter-temporal budget constraint of the government holds).
These conditions are objective but linked and linked in an uncertain way. They are linked because a change in the path of deficits or surpluses affects both the growth rate of income and the interest rate on sovereign. They are linked in an uncertain way because the size of the effects appears to depend on the state of the economy.
The conditions for sustainability are also subjective. Conditional on the uncertainty, the path of deficits and surpluses must be credible. The capacity of a government to control tax revenues and expenditure is key.
The focus on structural deficits and surpluses in the new fiscal treaty allows governments to have fiscal plans conditional on uncertainty. This is most welcomed as it increases the probability of success of the plans and therefore their credibility.


   

The pace of internal devaluation in Portugal

Beware, this is wonkish.
How long does it take for the competitive disinflation, also known as the internal devaluation, to occur in Portugal? The question is relevant for it is the market based mechanism to adjust to external imbalances within the euro. Here is an attempt to estimate the pace and the required adjustment. Starting the projection from the fourth quarter of 2011(when the unemployment rate was at 14.1 percent) I project an increase of the unemployment rate between 4 and 6 percentage points and an improvement of the real exchange rate of approximatively 5 percentage points, both in 20 quarters. Obviously shocks will happens and policies will be taken and the actual path will be different (as they have been in 2012). Nevertheless the forecasts can be interpreted as a counterfactual path in the absence of new shocks and policies and therefore should be of some guidance in designing policies aimed at rebalancing the external adjustment.