Thread by @DavideOneglia

This (quite long) thread is #my2cents on the output gap campaign #CANOO started by @RobinBrooksIIF and supported, among many others, by @alan_tooze and @MESandbu . Pls read it till the end. I don't want to be polemic. I'm just looking for answers (1/x)

https://twitter.com/RobinBrooksIIF/status/1138422290683744261

In EU this is a vital *political* debate. Given the well-known output gap measurement issues especially in real-time, references to 'cyclically-adjusted' fiscal balances in budgetary rules at EU level and in member states are a serious problem (2/x)

I sympathise with the claim that the Eurozone would benefit greatly from fiscal expansion both in aggregate and in specific countries, primarily Germany. Anaemic domestic demand and limited ECB policy ammunitions call for a fiscal response (3/x)

I also agree with the idea that those misguided policies depressed growth excessively both in aggregate and in specific countries, including Italy (4/x)

However, I think the evidence produced so far to support the *technical* argument that EA periphery output gaps are *much larger* than measured and particularly so in Italy is, at best, insufficient and disputable (5/x)

Capacity utilisation rates derived from business surveys are a pretty reliable way to determine the level of slack and unused productive factors in a sector (6/x)

For services, capacity utilisation indices are only available from 2010 so I show the level, but 90% sounds close to full capacity. Based on this there's an argument to say that Spain and Portugal still have large negative output gaps (7/x)

There are many reasons for it. At high level, PT suffered particularly from domestic demand compression, while ES added to that a dramatic re-balancing of its economy away from construction (8/x)

On the other hand, the capacity utilisation rates above and other data show that Italy might be in fact quite close to potential. E.g. the labour market is tightening (9/x)

Given that unemployment in ITA is basically flat, the normalisation of the job vacancy rates looks more like a *shift of* the Beveridge Curve than a *movement along* it. This is often regarded as a sign that unemployment is more likely to be structural than cyclical (10/x)

Wages per employee in ITA have been on the rise too , and, unlike in Spain, they constitute the bulk of nominal employee compensation growth lately (11/x)

Italy is a much more structural *supply-side* story than ES and PT. A secular decline is visible in any productivity statistic, from TFP to labour productivity (12/x)

And this is reflected in firms’ profits too, the trend has been quite negative in the past 20 years. No surprise net fixed capital formation stayed negative for several years (13/x)

If we agree that human capital counts towards potential, mass emigration complicates the story (14/x)

So, by using Italy as an example in the way it has been used so far, I don’t think we reinforce an otherwise legitimate #CANOO argument. Or, at least @RobinBrooksIIF et al. have more explaining to do in order to reconcile all the facts (15/x)

Finally, three words on low inflation: 1) it’s a global phenomenon, which doesn’t help to isolate the domestic component; 2) resource misallocation in EU are massive and more so in ITA, which dampens productivity and the remuneration of factors of production (16/x)

The top two reasons that come to mind to explain point 2 are: A) the very high share of micro enterprises and their low level of productivity, which in turn impacts wage growth and ultimately domestic inflation (17/x)

B) zombie lending. Both points A and B would require more explaining, but they seem to me primarily *supply-side* phenomena… (18/x)

If you are reading this, thank you very much for you attention!! I really look forward to your thoughts on the above.

cc: @FabioGhironi @monacelt @micheleboldrin @ThManfredi @Phastidio @ricpuglisi @kvenetis1 @gianlucac1

@adam_tooze apologies for the wrong spelling on the top tweet!