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I see tweets like this a lot:

Poor 2q growth shows its not just a "1q curse". Cannot ever cause eco recovery thru just #QE, low interest rates. #StructuralReforms

They seem to be saying essentially that structure should be the focus, not interest rates. What is an economic structural reform?

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  • $\begingroup$ Usually they're referring to supply-side policies: retraining of labour, making the labour market more 'flexible', decreasing unions' power, etc. These are seen as productivity boosters. $\endgroup$ – An old man in the sea. Aug 2 '16 at 17:33
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Economic variables can be "real" or "nominal". So when policymaker discus influencing the economy, they look at implications of influencing these economic variables.

An example of a nominal variable is the price level influenced by money supply. Money is directly created by the government and can take on any value per se and is not "real. E.g. if we multiply all prices and bank notes by 10 nothing in the economy changes.

Real variables are for example output, productivity etc.

However, it turns out that these nominal variables can influence the real ones. Increasing the money supply can increase output (at least temporarily). This is also easy to implement, so monetary policy is often used to fight a recession. Note that lowering the interest rate and increasing the money supply are two sides of the same coin and both part of monetary policy.

An alternative to monetary policy (based on nominal variables) would be "real" economic reforms. One form of "real" policy is a "structural reform". In this case you would try to increase output by changing something in the real side of the economy. For example lowering (wage) costs through changes to labor protection laws. Fiscal policy (government spending or tax cuts) is another form of "real" policy, however it is not a structural break.

To fully understand structural reforms we must introduce the concept of output potential. This is the output that would normally occur in absence of disturbances. It only depends on the underlying structure of the economy. These are factors such as costs (e.g. ease of doing business), labor market flexibility and other things that influence output in general in "real" terms. The economy generally comes back to that level and fluctuates around it in the medium run. (Note this level may be growing over time, e.g. by 1-2% each year).

However, sometimes it happens that our economy is operating below its "natural" potential. In this case we can employ monetary and fiscal policy to get back to that natural level. We can also push the economy beyond the natural level, but we will eventually come back, so this is not a good idea since the side effect that brings is typically more inflation.

If the crisis is because we are simply below potential, we do not need structural reforms. However if we are in a crisis because the potential or "natural" output has risen, then we need "structural reforms". An often cited recent example is the Greek crisis where Greece's wage rate increased a lot over time making its exports too expensive, meaning the economy did not have its past potential to export anymore. In this case many economists suggested "structural" reforms (law changes) that would lead to lower wages.

Monetary and Fiscal policy are often used to correct short-term problems or deviations from output potential. Structural reforms are supposed to change the (medium to long term) output potential itself.

The type of policy best suited often depends on the type of crisis at hand and its underlying causes.

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  • $\begingroup$ Where does fiscal policy fit in all of this? is it real, nominal or both? I think your answer would more complete, if it also comprehended fiscal policy... $\endgroup$ – An old man in the sea. Aug 2 '16 at 17:40
  • $\begingroup$ That's a very good point. I will make some edits to clarify things a bit more. Fiscal policy is neither really though, so its tricky. $\endgroup$ – BB King Aug 4 '16 at 13:31
  • $\begingroup$ in the short-run it can change output, and in open-economy it can even change medium-run equilibrium output. So, why do you say it's not 'structural'? In open-economy there's not only one equilibrium rate of unemployment, there's 1 for each different value of the real exchange rate... $\endgroup$ – An old man in the sea. Aug 4 '16 at 13:42
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See this article for a clarification of the term: http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-5

Applied to econometric modeling, structural breaks are (often policy) changes that impact stochastic processes, which we use as economic observables. That is to say that a structural reform, or even a change in the mechanisms governing the economy, are structural breaks. One of the greatest challenges in forecasting are future structural breaks and location shifts, as forecasting models can't account for them.

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  • $\begingroup$ Your answer is something I've never thought of. Does every structural policy count as a structural break? $\endgroup$ – An old man in the sea. Aug 2 '16 at 17:37

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