Fiscal multipliers and growth guesstimates Forecasts for the European Union covering 2012-2014 were out on Wednesday. FT Alphaville thinks the EC may be onto an important trend: The distress in more vulnerable Member States has progressively started to affect the remainder of the Union. Ode to the art of the understatement. So, anyway, what happened? The aggravation of the sovereign-debt crisis in the first half of the year, with rising market concerns about the long-term viability of the euro area and negative feedbacks between banks" funding pressures and economic activity, and to a lesser extent the unexpected slowdown in non-EU GDP growth and global trade, are the main reasons for the disappointing growth performance in 2012. Oh, yeah, that. Finger in the air to discern what the future will bring (goodness knows how they try to model the myriad of political factors here): Due to the weak starting point, the gradual recovery setting in in 2013 will result in a low annual GDP growth rate of ½% for 2013 in the EU, while GDP in the euro area will remain unchanged. GDP growth is forecast to rise in 2014 to around 1½% in the EU and the euro area, with domestic demand returning to provide a positive contribution to growth on the back of an expected normalisation of financing conditions, a stabilisation of sectoral balance sheets and returning confidence. Look, moving targets! Click before they change Or, to be serious with a chart for a moment: As for who exactly is letting the team down: But the highlight - fuel to fiscal multiplier debate (emphasis ours): A moderate decrease in the pace of fiscal consolidation is also reflected in the structural improvements of the budget balance, which in the EU is expected at 1 pp. of GDP in 2012 and ¾ pp. in 2013, and in the euro area at 1¼ pps. and just below 1 pp., respectively. The growth effect of a given consolidation effort depends on a number of factors (such as the composition of the fiscal effort, the credibility of the adjustment and financing conditions of the private sector), and it may currently be larger than in normal times in countries hit hard by the sovereign-debt crisis. The design of fiscal measures as well as their credible medium-term orientation are crucial to mitigate this impact. Which is really just a lead up to this: Without questioning that fiscal multipliers are probably larger than usual at the current juncture, this box assesses some of the evidence regarding forecast errors, focusing only on the euro area, and argues that much caution is warranted when using past forecast errors as indirect evidence for the true size of the fiscal consolidation multiplier. There are two reasons for that: first, the forecast errors over the 2010-11 period have been predominantly underestimations of higher-than-expected growth in 2010, which were in fact associated with stimulus measures in that year; second, when controlling for increases in sovereign-bond yields the correlation between forecast errors and changes in the fiscal stance breaks down. Shhh, don't all look at the IMF at once... Turn to Box 1.5 on "Forecast errors and multiplier uncertainty" for the full discussion. Related links: EU hits back at IMF over austerity - FT European Economic Forecast, Autumn 2012 (pdf) - European Commission