Potential output versus target unemployment in the EU fiscal framework: implications for the Italian economy of a change in perspective

The overall macroeconomic performance of the Eurozone in the last 25 years has not been brilliant. One major cause can be seen in the fiscal rules and their impact, particularly after the great financial crisis. The recently approved EU’s “New Economic Governance” framework has proven less innovative than expected. This paper critically assesses the revised framework, focusing on the central role of potential output. We argue that its methodology introduces a self-reinforcing circularity, as potential output converges quickly towards actual output. This approach risks driving EU economies onto a declining growth path, as actual output growth heavily depends on public spending, constrained to remain below potential output projections. Drawing on the Italian case and earlier fiscal adjustments, we highlight the shortcomings of this framework and its implications for sustainable economic growth. To address these limitations, we propose a fiscal strategy centered on achieving a “target” GDP level consistent with a low, feasible unemployment rate. Using simulations inspired by Fontanari et al. (2022), Carnazza et al. (2023), and Uxò et al. (2024), we evaluate the trajectory of the Italian economy under different scenarios of fiscal multipliers and interest rates. The analysis explores whether a growth-oriented fiscal policy, aimed at reducing unemployment, can simultaneously satisfy EU requirements for reducing debt-to-GDP and deficit-to-GDP ratios within a five-year adjustment period. Our findings suggest that progressive, employment-focused policies might reconcile economic and social goals with fiscal sustainability, offering a viable alternative to traditional austerity-driven approaches.