The Output Gap and Cyclical Movements of Tourism, GDP and Their Transmission Mechanism: Case of Croatia

Abstract

The output gap, usually defined as the difference between the real GDP and that of the potential GDP, indicates the imbalance existing in a real economy. The output gap is based on the definition of unobserved potential output. This article presents estimations of the output gap in Croatian economy in the long run. The co-integration analysis is used to estimate the Cobb-Douglas production function of aggregate output from 1952-2004 and the Vector Error-Correction model is developed to analyze the relationships between output and production factors. The output gap is obtained with full labor force utilization corrected by the NAWRU rate. We described potential GDP as the maximum quantity of output the economy can produce under conditions of full employment (which is understood as the maximum level of employment not generating wage inflationary pressures). To identify the transmission mechanism of observed cyclical components of Croatian GDP and tourism output, we used a multi-equation framework by means of a VAR model.