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Friday, November 21, 2014 12:06 AM

Output Gap Idiocy; Shaky Accounting EU and US Style

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Shaky Accounting EU Style

Inquiring minds note that Italy Accuses Brussels of ‘Shaky’ Accounting. That's certainly not a shocking accusation.

"Shaky" is exactly what one should expect when you get a bunch of nannycrats who believe Nirvana is on the horizon if wealth and taxes could be redistributed properly.

The irony in this case is that Italy pleads for far shakier accounting than Brussels. Let's dive in for a closer look.

Italy has accused the EU of using “shaky” methodology to evaluate countries’ fiscal policies, raising the stakes ahead of next week’s first verdict on the budgets of eurozone member states by the new European Commission.

In an interview with the Financial Times, Pier Carlo Padoan, Italy’s economy minister, said the EU’s measure of output gaps – or the amount by which a country’s gross domestic product falls short of its potential – was outdated and underestimated the depth of the recessions which followed the financial crisis.

The size of Italy’s output gap is crucial because the EU uses it to calculate structural budget deficits, which take into account the impact of economic cycles. The greater the output gap, the greater the leeway conceded by the EU on fiscal matters.

The EU’s measure of the Italian output gap is 3.5 per cent of GDP. Mr Padoan noted that this figure was significantly lower than the equivalent one from the Organisation for Economic Co-operation and Development, of which he has been chief economist. The Paris-based body has estimated Italy’s output gap to to be 5.1 per cent this year, with a new and possibly higher projection due next week.

Mr Padoan added that if the latter number were applied, Italy “would be in structural surplus now and . . . for a long time”. “We would be in a different world, [with] no requests for additional resources, we would have to do nothing. It would change a lot,” he added.
Italy's Argument

Italy actually argues it would be in surplus if only Brussels would admit that Italy is 5.1% in the hole rather than 3.5% in the hole!

The idea that 5.1% in the hole is better than 3.5% in the hole is of course ludicrous. It's even more insane to propose that one has a surplus at 5.1% in the hole but not at 3.5% in the hole.

Clearly Brussels' math is idiotic, but Italy's math is even worse.

I keep wondering "Will the lunacy ever stop?" Yet, we all know the answer: "No, it won't".

Output Gap Idiocy

The idea that a nation can measure an "output gap" is an idiocy in and of itself. Here are four reasons.

  1. Alleged "output gaps" are measured off historical growth patterns, but those patterns are of an insufficient timeline to be meaningful.
  2. Huge structural changes are in play, including Italy's move to the euro. 
  3. Poor demographics. Aging populations are highly unlikely to grow at previous trends.
  4. It is impossible to accurately measure output in a fiat-based, fractional-reserve credit system with absolutely no controls on monetary printing or trade imbalances.

Yet, we hear the same "output gap" nonsense in the US. The Fed is a big believer in it.

Interestingly, all four rules above are in play, even for the US.

How so?

Simply replace point number two above with Nixon closing the gold window. Credit soared and along with it GDP. That artificial boom in GDP now constitutes part of the alleged "output gap".

 Mike "Mish" Shedlock

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