Showing papers on "Potential output published in 2016"

Measuring the Natural Rate of Interest Redux

Abstract: Persistently low real interest rates have prompted the question whether low interest rates are here to stay. This essay assesses the empirical evidence regarding the natural rate of interest in the United States using the Laubach-Williams model. Since the start of the Great Recession, the estimated natural rate of interest fell sharply and shows no sign of recovering. These results are robust to alternative model specifications. If the natural rate remains low, future episodes of hitting the zero lower bound are likely to be frequent and long-lasting. In addition, uncertainty about the natural rate argues for policy approaches that are more robust to mismeasurement of natural rates.

The trend–cycle decomposition of output and the Phillips curve: Bayesian estimates for Italy and the Euro area

Abstract: A standard model-based trend–cycle decomposition of Italian GDP yields a likelihood function that is relatively flat. Bayesian estimation of the model allows to impose a mildly informative prior on the parameter governing the periodicity of the cycle, and thus, it helps to achieve the preferred decomposition. In a bivariate output and Phillips curve model for Italy, it is found that (i) the median response of prices to a 1 % shock to the output gap is equal to about 0.5 % after 20 quarters, (ii) the inflation cycle lags GDP on average by about three quarters. Estimating the model with Euro area data provides evidence of a smaller impact of the output gap on prices (0.4 %) and a lower lag of the inflation cycle with respect to GDP.

The performativity of potential output: Pro-cyclicality and path dependency in coordinating European fiscal policies

Abstract: This paper analyzes the performative impact of the European Commission’s model for estimating 'potential output', which is used as a yardstick for measuring the 'structural budget balance' of EU countries and, hence, is crucial for coordinating European fiscal policies. In pre-crisis years, potential output estimates amplified the build-up of private debt, housing bubbles and macroeconomic imbalances. After the financial crisis, they were revised downwards, which increased fiscal consolidation pressures. By focusing on the euro area's economies during 1999-2014, we identify two performative aspects of the potential output model. First, the political implications of the model led to a pro- cyclical feedback loop, reinforcing general economic developments. Second, the model has contributed to national lock-ins on path dependent debt trajectories, fueling 'â€sstructural polarization' between core and periphery.

The Positive Effect of Public Investment on Potential Growth

Abstract: An estimated baseline convergence model capturing the long-term effect of human capital and physical investment on potential output for a panel of OECD countries is augmented with public investment and its components. The estimations suggest that public investment has a positive effect on long-term growth and on labour productivity. Public investment can also increase the speed of convergence of catching-up countries. Public investment is more beneficial in some areas than others. This is particularly the case of public investment in health and in research and development. There is also evidence that growth gains from increasing public investment may decline at a high level of the public capital stock due to decreasing returns

Trading on Their Terms? Commodity Exporters in the Aftermath of the Commodity Boom

Abstract: Commodity prices have declined sharply over the past three years, and output growth has slowed considerably among countries that are net exporters of commodities. A critical question for policy makers in these economies is whether commodity windfalls influence potential output. Our analysis suggests that both actual and potential output move together with commodity terms of trade, but that actual output comoves twice as strongly as potential output. The weak commodity price outlook is estimated to subtract 1 to 2¼ percentage points from actual output growth annually on average during 2015-17. The forecast drag on potential output is about one-third of that for actual output.

Rethinking potential output : embedding information about the financial cycle

Abstract: This paper argues that information about the financial cycle should be incorporated in measures of potential output. Identifying potential output with non-inflationary output is too restrictive given that growing financial imbalances can place output on an unsustainable path even if inflation is low and stable. We propose a simple and transparent framework to accommodate information about the financial cycle in constructing output gap estimates. Applied to US data, our approach yields measures of potential output that are not only estimated more precisely, but also much more robust in real time. Inflation, by comparison, carries very little information that can be exploited to infer potential output.

Links between weak investment and the slowdown in productivity and potential output growth across the OECD

Abstract: The OECD framework for estimating potential output is combined with previous OECD empirical research to analyse the causes of recent weak productivity growth. Current weak labour productivity growth in many OECD countries reflects historically weak contributions from both total factor productivity (TFP) growth and capital deepening. The slowdown in trend productivity growth in the pre-crisis period is mostly explained by a long-established slowdown in TFP growth, but since the crisis, the further deceleration is mainly due to weak capital deepening, a development apparent in practically every OECD country. Much of the weakness in the growth of the capital stock since the financial crisis can be explained by an accelerator response of investment to continued demand weakness, leading in turn to a deterioration in potential output via a hysteresis-like effect. Circumstantial evidence suggests that a misallocation of capital in the pre-crisis period also contributed to the slowdown in capital stock growth, particularly among the most severely affected countries. In many OECD countries, declining government investment as a share of GDP has further exacerbated post-crisis weakness in capital stock growth, both directly and probably indirectly via adverse spillover effects on business investment. Finally, at a time when the use of conventional macro policy instruments has become increasingly constrained, the slower pace of structural reform represents a missed opportunity, not least because more competitionfriendly product market regulation could have boosted both investment and potential growth.

An investigation into improving the real-time reliability of OECD output gap estimates

Abstract: Estimates of the output gap ought to be a useful guide for macroeconomic policy, both for assessing inflationary pressures and fiscal sustainability, but their reliability has been called into question by the large revisions which they are often subject to, particularly around turning points. Revisions to OECD published estimates of the output gap around the period of the financial crisis have been exceptionally large, with by far the largest contribution to these revisions coming from the labour-efficiency gap. The current paper investigates a modification to the standard OECD production function method for deriving potential output, which involves an additional cyclical adjustment in the derivation of trend labour efficiency. The additional adjustment helps to reduce the occurrence of large end-point revisions and of sign switches between the initial and final estimates of the labour-efficiency gap. The variables which are most often found to be useful in providing this cyclical adjustment of labour efficiency are manufacturing capacity utilisation and the investment share. However, for a few countries additional variables – house prices and credit – have been used to provide the cyclical adjustment, although this raises an issue as to whether the cyclical adjustment should be limited to a core set of variables to ensure the method remains reasonably homogenous across countries. Recent improvements to the specification of the Phillips curve, which imply a tighter fit between the unemployment gap and inflation, should also reduce end-point revisions to the unemployment gap in future.

Lower for Longer: Neutral Rate in the U.S.

Abstract: We use a semi-structural model to estimate neutral rates in the United States. Our Bayesian estimation incorporates prior information on the output gap and potential output (based on a production function approach) and accounts for unconventional monetary policies using estimates of “shadow” policy rates. Results show a significant trend decline in the neutral real rate post-1990s, driven only in part by a decline in trend growth, whereas other factors (including excess global savings and risk premia) matter. Neutral rates likely turned negative during the global financial crisis and are expected to increase only gradually looking forward.

Potential Growth of the Spanish Economy

Abstract: This paper presents an estimate of the Spanish economy’s potential growth. This estimate is based on a production function methodology that includes certain refinements on previous versions and generates less procyclical potential output growth estimates than those traditionally considered in the literature. As a result, the (positive) output gap estimated in expansions is higher and that estimated in recessions is lower. According to these results, given the available population projections and under the assumption that total factor productivity (TFP) and structural unemployment will behave in line with historical patterns, the Spanish economy’s potential growth is expected to recover gradually over the coming years but, in line with projections by international organisations, to lower rates than those in the expansion period. However, per capita growth rates fully recover to the pre-crisis levels, which highlights the importance of population projections in shaping the Spanish potential growth.

China's slowdown and rebalancing: potential growth and poverty impacts on Sub-Saharan Africa

Abstract: This paper explores the economic impacts of two related tracks of China's expected transformation—economic slowdown and rebalancing away from investment toward consumption—and estimates the spillovers for the rest of the world, with a special focus on Sub-Saharan African countries. The paper finds that an average annual slowdown of gross domestic product in China of 1 percent over 2016–30 is expected to result in a decline of gross domestic product in Sub-Saharan Africa by 1.1 percent and globally by 0.6 percent relative to the past trends scenario by 2030. However, if China's transformation also entails substantial rebalancing, the negative income effects of the economic slowdown could be offset by the positive changes brought along by rebalancing through higher overall imports by China and positive terms of trade effects for its trading partners. If global supply responds positively to the shifts in relative prices and the new sources of consumer demand from China, a substantial rebalancing in China could have an overall favorable impact on the global economy. Economic growth could turn positive and higher on average, by 6 percent in Sub-Saharan Africa and 5.5 percent globally, as compared with the past trends scenario. Finally, rebalancing reduces the prevalence of poverty in Sub-Saharan Africa compared with the isolated negative effects of China's slowdown, which slightly increase the incidence of poverty. Overall, China's slowdown and rebalancing combined are estimated to increase gross domestic product in Sub-Saharan Africa by 4.7 percent by 2030 and reduce poverty, but the extent of this varies by country.

Real-Time Properties of the Federal Reserve's Output Gap

Abstract: We consider the revision properties of Federal Reserve Board staff estimates of the output gap after the mid-1990s and examine the usefulness of these estimates for inflation forecasting. Over this period, we find that the Federal Reserve's output gap is more reliably estimated in real time than previous studies have documented for earlier periods and alternative estimation techniques. In contrast to previous work, we also find no deterioration in forecast performance when inflation projections are conditioned on real-time rather than on final estimates of the output gap.

How to explain errors in budget balance forecasts in euro area countries? Empirical evidence based on real-time data

Abstract: The aim of this study is to explore budget planning in the euro area countries in 2004-2014. Our analyses are based on annual real-time data from the IMF World Economic Outlook publications. As forecasts made by different institutions are strongly correlated, our dataset reasonably reflects information available for policy makers in real-time. We examine whether real-time forecasts of overall budget balance, real GDP growth and output gap have been systematically biased. We also analyse forecast accuracy of potential output growth, which we construct using different vintages of real-time data. Our results indicate systematic biases in forecasts. Further, we study how real-time macroeconomic conditions affect budget planning. For comparison, we also consider how ex post economic conditions and ex post budget balance developments are related. We find robust evidence of mean reversion in budget balances, in both real-time and revised data. Mean reversion is related only to negative budget balances, and it is systematically stronger with respect to revised information. Finally, we analyse errors in budget balance forecasts. We provide robust evidence that revisions to current budget balance have contributed to errors in budget balance forecasts. We also find that forecasted macroeconomic conditions (potential output growth and real GDP growth) and their revisions have affected errors in budget balance forecasts. Overall, our results indicate that real-time uncertainty and revisions materially affect budget planning.

The Natural Rate of Interest in Taylor Rules

Abstract: The Taylor rule suggests that the federal funds rate should be adjusted when inflation deviates from the Fed's inflation target or when output deviates from the Fed's estimate of potential output. Typical formulations of the rule assume that the level of the inflation-adjusted federal funds rate that is expected to prevail in the long run, sometimes thought of as the "natural" rate of interest, is constant over time. Since this assumption is likely incorrect, we show how the Taylor rule can account for a variable natural rate by incorporating long-term productivity growth. We also show that better monetary policy outcomes may be achieved if the Fed regularly adjusts the funds rate in response to perceived changes in productivity growth, even if these changes are often measured with error.

Is European Unemployment Classical or Keynesian

Abstract: European unemployment rose sharply beginning in the mid-1970's and remains very high today, yet policymakers seem reluctant to pursue fiscal and monetary actions that would greatly stimulate aggregate demand. Traditional Keynesian policies may be impeded by a belief that rising unemployment is not so much Keynesian, arising from shortfalls in aggregate demand, as it is "classical," originating from a failure of real wages to adjust to changing market conditions, particularly reduced rates of productivity growth. To determine the extent of classical vs. Keynesian unemployment, we apply a theoretical approach developed by Hickman (1987) to econometric models of labor supply and demand in selected European countries and the United States. The models are used to determine the time paths of the natural unemployment rate, potential output, and the full-employment real wage that clears the labor market at the natural rate of unemployment. The computed potential paths are benchmarks for measuring shortfalls of aggregate demand and excesses of actual over full-employment real wages. Effects of eliminating wage gaps are studied in counterfactual simulations, which provide information for decomposing unemployment into its natural, Keynesian, and classical components.

Schumpeterian Macroeconomic Production Function for Open Economies: A New Endogenous Knowledge and Output Analysis

Abstract: The macroeconomic production function is a traditional key element of modern macroeconomics, as is the more recent knowledge production function which explains knowledge/patents by certain input factors such as research, foreign direct investment or international technology spillovers. This study is a major contribution to innovation, trade, FDI and growth analysis, namely in the form of a combination of an empirically relevant knowledge production function for open economies - with both trade and inward FDI as well as outward foreign direct investment plus research input – with a macro production function. Plugging the open economy knowledge production function into a standard macroeconomic production function yields important new insights for many fields: The estimation of the production potential in an open economy, growth decomposition analysis in the context of economic globalization and the demand for labor as well as long run international output interdependency of big countries; and this includes a view at the asymmetric case of a simple two country world in which one country is at full employment while the other is facing underutilized capacities. Finally, there are crucial implications for the analyis of broad regional integration schemes such as TTIP or TPP and a more realistic and comprehensive empirical analysis.

The European Commission's New NAIRU: Does it Deliver?

Abstract: The non-accelerating inflation rate of unemployment (NAIRU) is a key component of potential output and as such critically affects output gap estimates. In May 2014, the European Commission changed its specification of the NAIRU for several countries and lowered its NAIRU estimates – in the case of Spain from 26.6% to 20.7% for 2015. To test the dependence of the new NAIRU on unemployment versus structural factors, we run counterfactual simulations applying 1SD shocks to actual unemployment and to the structural variable – real unit labour costs. We find that the NAIRU in its new specification is still largely determined by actual unemployment. This calls in question both the interpretation of potential output estimates as barriers to more vigorous inflation-stable economic activity and the accuracy of structural deficit figures.

Potential Output, Output Gap and Fiscal Stance: is the EC estimation of the NAWRU too sensitive to be reliable?

Abstract: EU fiscal governance builds on the concept of Potential Output, the highest level of production an economy can sustain without incurring in inflationary pressure. Unfortunately, Potential Output is not observable and must be estimated. There are many techniques to obtain a guess value of the potential of an economy, each of which with pros and cons. The methodology adopted by the European Commission and EU Member States, while consistent with most of the recent economic and econometric theory, is still not robust enough to give a unique and irrefutable measure on which to base EU’s fiscal framework. Should the fiscal governance continue to be based on this concept, further extension of the methodology must be implemented in order to obtain more robust estimates.

A Multivariate Filter to Estimate Potential Output and NAIRU for the Maltese Economy

Abstract: This paper applies a multivariate filter on a small macroeconomic model to derive estimates of Malta’s potential output growth, the output gap and NAIRU. The unobservable variables are derived from a system that incorporates long-standing relationships in economic theory, such as the Phillips Curve and Okun’s Law, while also allowing for hysteresis effects. Given the structural changes in the Maltese economy, with a shift over the past decade from traditional industries such as manufacturing towards higher-value added and export-oriented services, the model replaces a common variable used in the literature, capacity utilization in manufacturing, with two foreign variables, demand and imported inflation. The inclusion of foreign variables is important since Malta is one of the most open economies in the world with a high degree of import content. The model is also able to account for the high degree of volatility manifested in the time series of very small open economies. The estimates from the multivariate filter are compared with those derived from alternative approaches. Despite the negative impact from the financial crisis of 2009, by 2014 potential output growth had already surpassed the pre-crisis growth rates. The crisis had no permanent impact on NAIRU. This performance is clearly at odds with that of other European economies and bodes well for Malta’s convergence process.

What's 'structural' about unemployment in Europe: On the Determinants of the European Commission's NAIRU Estimates

Abstract: This paper analyzes the determinants of the European Commission's NAIRU estimates for 14 European OECD countries during 1985-2012. The NAIRU is a poor proxy for 'structural unemployment': Labor market institutions - employment protection legislation, union density, tax wedge, minimum wages - underperform in explaining the NAIRU, while cyclical variables - capital accumulation and boom - bust patterns in housing markets - play an important role. This is relevant since the NAIRU is used to compute potential output and structural budget balances and, hence, has a direct impact on the scope and evaluation of fiscal policy in EU countries.

What Determines Output Losses after Banking Crises

Abstract: We examine the output costs associated with 150 banking crises using cross country data for years after 1970. Many banking crises do not lead to contractions and most banking crises do not lead to large contractions, a result that holds for developed and developing economies. We examine which variables help to predict output changes after a banking crisis using Bayesian Model Averaging. For developed economies, we find that the output losses are positively related to prior economic conditions such as credit growth. For low-income economies, we find that other factors such as having a stock market and deposit insurance are more important.

Adjusting the External Adjustment: Cyclical Factors and the Italian Current Account

Abstract: We investigate the role of cyclical factors in the adjustment of Italy’s external balance from 2010, developing a model that infers the potential levels of domestic demand and of imports and exports from an exogenous measure of potential output, in an internally coherent fashion and also taking composition effects into account. According to our results, in 2015 Italy’s cyclically-adjusted current account surplus came to about 0.5 percentage points of GDP; the overall external rebalancing of the Italian economy has largely been of a non-cyclical nature, with a positive contribution from the decline in the prices of energy commodities. By applying our methodology to the other major euro-area countries, we find that current account imbalances over the recent period are amplified when assessed in cyclically-adjusted terms.

Estimating Potential Output in Chile : A Multivariate Filter for Mining and Non-Mining Sectors

Abstract: Using a multivariate filter, we estimate potential growth rates in Chile’s mining and non-mining sectors. Estimates for the mining sector incorporate information on copper prices, whereas estimates for non-mining reflect information on inflation and unemployment rates. To better understand the drivers of potential growth, we decompose estimates into capital, labor (adjusted for human-capital and hours worked), and total-factor productivity using a production-function. Our estimates of potential output in Chile suggest that an important part of the recent growth slowdown has been structural, with potential-output growth slowing to 2½ percent in recent years, although it plausibly could be higher in the medium-term.

Slow Trade: Structural and Cyclical Factors in Global Trade Slowdown

Abstract: Global trade growth has slowed down since the global financial crisis in 2008 and has been below the global GDP growth rate. This sluggish growth of global trade, the so-called "Slow Trade," has been remarkable in emerging economies and for capital, intermediate, and consumer durable goods. There are three main backgrounds of this global trade slowdown: (1) a decline in the global real GDP growth, (2) a structural decline in the long-run income elasticity of trade due to changes in the global demand structure, expanding in-house production in China, and deceleration in the expansion of global value chains, and (3) short-term negative shocks. Our quantitative analysis indicates that structural factors such as declines in global potential output growth and in the long-run income elasticity of trade explain about 70 percent of the global trade slowdown, and cyclical factors such as remaining negative output gap and temporary negative shocks explain the rest, about 30 percent. It is unlikely that the part of the slowdown caused by structural factors will be immediately restored, while the negative impact of cyclical factors is expected to gradually become smaller. Our empirical result indicates that the current estimate of the long-run income elasticity of trade is about 1.0, which implies that the growth rate of global trade is expected to recover up to the growth rate of global real GDP. However, there still remain large uncertainties in terms of global trade, such as the economic relationship between the United Kingdom and the European Union and the development of rebalancing in emerging countries, and thus the effects of those uncertainties on global trade should be noted.

Output Gaps, Inflation and Financial Cycles in the United Kingdom

Abstract: This paper aims at constructing potential output and output gap measures for the United Kingdom which are pinned down by macroeconomic relationships as well as financial indicators. The exercise is based on a parsimonious unobserved components model which is estimated via Bayesian methods where the time-paths of unobserved variables are extracted with the Kalman filter. The resulting measures track current narratives on macroeconomic cycles and trends in the United Kingdom reasonably well. The inclusion of summary indicators of financial conditions leads to a more optimistic view on the path of UK potential output after the crisis and adds value to the model via improving its real-time performance. The models augmented with financial conditions have some inflation forecasting ability over the monetary policy relevant two to three-year horizon during the last fifteen years, although this ability diminishes in a real-time setting. Finally, we also introduce a new approach to constructing financial conditions indices, with emphasis on their real-time performance and ability to track the evolution of macro-financial imbalances. Our results can be relevant from both monetary and macro-prudential policy perspectives.