Potential Output Growth Research Articles

Structural Breaks in Potential GDP of Four Major Economies: Just Impaired Credit or the New Normall?

This paper investigates the factors behind the recent growth slowdown (so-called Secular Stagnation) in the US, the euro area and Japan using the metrics of potential output growth. Specifically, our results offer limited support for an impaired credit transmission channel hypothesis (Reinhart and Rogoff, 2009a), while not supporting a supply slowdown hypothesis (Gordon, 2012). We propose a unified framework to test those hypotheses based on structural break tests of potential output. We estimate a variety of potential output growth models accounting for inflation, unemployment, and private credit dynamics (finance-neutral estimates) with multivariate Kalman filters and subject our estimates to structural break tests. We detect structural breaks between 2008 and 2010 for all three countries with Bai-Perron search procedure, the result being robust to the model specification and sample choice, with no significant difference between ordinary and finance-neutral estimates. We proceed with the Chen-Liu test to detect negative temporary change outliers in the Great Recession for the US and the euro area and negative level shift outliers for Japan. Moreover, original breaks in the Chen-Liu test disappear in the US and the euro area once we account for private credit and labour market dynamics, but do not change for Japan.

UK medium‐term prospects: steady, but unspectacular

Rapid expansion of the labour supply and robust business investment means that potential output is likely to have grown strongly last year. Therefore, based upon the latest data for GDP, we estimate that the output gap only narrowed very slightly in 2014, ending the year at 4% of potential output. The prospects for potential output growth are favourable, with the labour supply set to be boosted by sustained strength in inward migration and the staged increase in the State Pension Age, and robust growth in business investment continuing to deepen the capital stock. This will provide the conditions for relatively strong growth and low inflation over the medium term, with GDP growth expected to average 2.6% a year from 2015–19. This is some way below the average of the decade prior to the financial crisis, but it would represent a clear step up on the average growth rate achieved between 2007–14. Our estimate of the output gap is much larger than that of the OBR. This suggests that the UK's structural deficit is smaller and that the degree to which fiscal policy needs to be tightened may not be as great as the OBR estimates.

The Labor Market in the Aftermath of the Great Recession

The Great Recession took a large toll on the U.S. labor market, reducing jobs and raising unemployment across most sectors and among workers of all skill levels. Although conditions have improved over the last five years, by most metrics the labor market recovery remains incomplete. The slow progress of recovery has raised concerns that some of the damage done by the recession will be permanent, and that a return to prerecession conditions is unlikely. This paper argues that although the recession coincided with, and even accelerated ongoing structural changes in the economy, most of the disruptions were cyclical and will likely be repaired over time. Should things evolve otherwise, the impact on the potential output and future growth of the economy could be profound.

Dynamic activity analysis model-based win-win development forecasting under environment regulations in China

Porter hypothesis states that environmental regulation may lead to win-win opportunities, that is, improve the productivity and reduce the undesirable output simultaneously. Based on directional distance function, this paper proposes a novel dynamic activity analysis model to forecast the possibilities of win-win development in Chinese industry between 2011 and 2050. The consistent bootstrap estimation procedures are also developed for statistical inference of the point forecasts. The evidence reveals that the appropriate energy-saving and emission-abating regulation will significantly result in both the net growth of potential output and the increasing growth of total factor productivity for most industrial sectors in a statistical sense. This favors Porter hypothesis.

COMMON AGRICULTURAL POLICY 2007 – 2013 VS. 2014 -2020

Slovakia is perceived as a leader among the European countries due to its size of farms. Despite of a high concentration of farms - up to 95.1% of the utilized agricultural land are farmed by large farms - the Slovak agriculture is considerably less productive. The reform of Common Agriculture Policy tries to develop not only the traditional role of agriculture, a food production, but shapes the face of country, affects the quality of environment and also helps to increase the potential of tourism development through the cooperation of direct payments system, capping and greening. To make a right decision in allocation of this support, it is necessary to become familiar with its advantages and disadvantages especially in Slovak agricultural conditions: Direct payments system – the use of objective criteria would ensure a more equitable and efficient use of budgetary resources in comparison to e.g. EU flat rate, where Slovakia is paid with lower direct payments than the other Member States. Objective criteria reflect the dual role of direct payments in providing income support and public goods. Capping - The primary objective of capping is to increase the downward nature of employment in animal production, or at least to maintain its current state in Member States like Slovakia, Czech Republic or Germany, where the biggest farms are located due to the historical development. In previous years, the animal production has been forgotten regarding to higher payments paid to the crop production. This unbalance could be changed by reform of Common Agriculture Policy. Greening – opponents of green rules, which should ensure the maintaining of the permanent pastures; diversification and maintaining the ecological landscape” highlight their possible negative impacts like reduction in the competitiveness of Slovak agricultural products; decrease of potential output growth; increased costs in crop production; etc. But one of its indisputable advantage hides in the opportunity to spread the crop of soybeans and pulses that could be a rewarding alternative of possible farms losses in these increasingly hotter summers.

Measuring Contributions of Labor, Capital and Technology in Indian Manufacturing Sector - A Cobb Douglas Production Function Approach

The production function method for the measurement of potential output growth takes into account different sources of an economy's productive capacity, namely of labour, capital and total factor productivity later on including information on technological and allocative efficiency. A production function shows the technological relationship between the maximum output obtainable from a given set of inputs and the relationship between inputs in the existing state of technological change. In this paper , a Cobb Douglas form of production function has been used to measure the contribution of labour, capital and technology for Indian Economy. The basic data source of the study was Annual Survey of Industries (ASI) published by Central Statistical Organization (CSO), Government of India covering the period from1999-00 to 2010-11. Findings of the statistical analysis are that out of five sectors, three sectors namely Public Limited Company, Government Department Enterprises and Aggregate Corporate sector had recorded increasing returns to scale and the remaining sectors namely the Private Limited company and the Public corporation recorded decreasing returns to scale. Results also show that percentage share of wages was high compared to the percentage share of capital in all the sectors.

TREND-CYCLE DECOMPOSITION OF OUTPUT AND EURO AREA INFLATION FORECASTS: A REAL-TIME APPROACH BASED ON MODEL COMBINATION

This paper estimates univariate and multivariate trend-cycle decomposition models of GDP and considers the novel possibility of regime switches in the growth of potential output. We compute both ex post and real-time estimates of the output gap to check the stability of our estimates to GDP data revisions. We find some evidence of regime changes in the growth of potential output during the recessions experienced by the euro area. We also run a forecasting experiment to evaluate the predictive power of the output gap for inflation. The benchmark autoregressive model tends to obtain the best forecasts for one-quarter-ahead forecasts, but the output gap measures help to forecast inflation for longer horizons.

A study of potential output and output gap in the Czech Republic

Analysis of economic cycle is of enormous importance for monitoring economic output and explaining price and wage inflation. It provides essential information for shaping economic and monetary policy of central authorities. Several methods are currently available to estimate potential output and output gap. In the current study, methods of Hodrick-Prescott filter and Cobb-Douglas production function were implemented to estimate potential output, which cannot be empirically observed. For the purpose of comparing the above methods, quarterly and annual time series of real GDP, labour and gross fixed capital starting in 1996 were used for estimation of the output gap. Relative contributions of labour, fixed capital formation and technology improvement factor towards growth of potential output were quantified for the studied series. The Cobb-Douglas production function appears to be superior to Hodrick-Prescott filter in providing quality estimates of potential output. Hodrick-Prescott filter allows estimation of potential output; nevertheless, it fails to identify components of cyclic behaviour of economic activity. Cobb-Douglas production function describes level of potential product assuming average utilization of production factors. A detailed analysis of components of economic growth in the observed period is provided.

Does Factor Accumulation or Productivity Change Drive Output Growth in the Indian Sugar Industry? An Inter-state Analysis

The study endeavors to break down output growth in the Indian sugar industry into the ‘perspiration’ component that corresponds to factor accumulation and the ‘inspiration’ component that corresponds to the total factor productivity (TFP) growth. The bootstrapped Malmquist productivity index has been used as a technique to obtain the TFP growth from the period 1974/75 to 2004/05. Empirical analysis reveals that output growth in the Indian sugar industry is equally driven by the inspiration component (i.e., TFP growth) and the perspiration component (i.e., factor accumulation), but in opposite directions. The inspiration component is observed to contribute to output growth positively, whereas the perspiration component contributes negatively. Given substantial TFP growth, the potential output growth in the Indian sugar industry has been restricted primarily by the negative growth of inputs during the entire study period and particularly in the post-reform period.

Global Financial Crisis: Reflections on Its Impact on India

The Indian economy looked to be relatively insulated from the global financial crisis that started in August 2007 when the sub-prime mortgage crisis first surfaced in the United States (US). In fact, the Reserve Bank of India (RBI) was raising interest rates until August 2008 with the explicit objective of cooling the economy and bringing down the gross domestic product (GDP) growth rate, which visibly had moved above the rate of potential output growth and was contributing to the buildup of inflationary pressures in the economy. This paper attempts an analysis of the origin and causes of global financial crisis and the impact of the crisis on the Indian economy.India, South Asia’s largest economy, has been facing major challenges owing to the global financial crisis. The immediate effects were plummeting stock prices, a net outflow of foreign capital, a large reduction in foreign reserves and a sharp tightening of domestic liquidity. These caused a rapid depreciation of the exchange rate and a surge in short-term interest rates. The second round effects emerged from a slowdown in domestic demand and exports. Demand effects have been particularly severe in housing, construction, consumer durables and the IT sector. As a result, manufacturing production has taken a hit and activities in the organized services sector (housing, construction, IT) are down sharply. Exports declined for two consecutive months in October and November 2008. A recent government study estimates job losses to the tune of five hundred thousand between October and December 2008. GDP growth rate is now estimated at around 7 percent for 2008, down from 9 percent in 2007, and is projected to decline to around 5 percent in 2009. The monetary and fiscal stimulus package is expected to contain the downward slide in demand in 2009 while providing a good basis for recovery in 2010.

Post-Crisis Potential Output in the Western Balkans

Abstract Spurred by the recent global economic crisis, there has been a resurgence of research on output gaps. As the crisis caused a decline in potential GDP due to a strong contraction in demand, it is expected that the recovery of potential output will be especially difficult in demand-driven small open economies, such as the Western Balkan countries, where recovery will strongly depend on global international trade recovery. The purpose of this research is to calculate and compare pre and post-crisis potential GDPs and GDP gaps for the Western Balkan countries. The symmetric filter method developed by Hodrick and Prescott is used to de-trend GDP time series data by decomposing it into growth and cyclical components. The results point to a strong decrease in potential output growth compared to the pre-crisis potential output growth of the Western Balkans.

Do Recessions Affect Potential Output?

A number of previous studies have looked at the effect of financial crises on actual output several years beyond the crisis. The purpose of this paper is to examine whether the growth of potential output also is affected by recessions, whether or not they include financial crises. Trend per capita output growth is calculated using HP filters, and average growth is compared for the two years preceding a recession, the two years immediately following a recession peak, and the two years after that. Panel regressions are run to determine whether characteristics of recessions, including depth, length, extent to which they are synchronized across countries, and whether or not they include a financial crisis, can explain the cumulative four-year loss in the level of potential output following an output peak preceding a recession. The main result is that the depth of a recession has a significant effect on the loss of potential for advanced countries, while the length is important for emerging markets. These results imply that the Great Recession might have resulted in declines in trend output growth averaging about 3 percent for the advanced economies, but appear to have had little effect on emerging market trend growth.

Do Recessions Affect Potential Output?

A number of previous studies have looked at the effect of financial crises on actual output several years beyond the crisis. The purpose of this paper is to examine whether the growth of potential output also is affected by recessions, whether or not they include financial crises. Trend per capita output growth is calculated using HP filters, and average growth is compared for the two years preceding a recession, the two years immediately following a recession peak, and the two years after that. Panel regressions are run to determine whether characteristics of recessions, including depth, length, extent to which they are synchronized across countries, and whether or not they include a financial crisis, can explain the cumulative four-year loss in the level of potential output following an output peak preceding a recession. The main result is that the depth of a recession has a significant effect on the loss of potential for advanced countries, while the length is important for emerging markets. These results imply that the Great Recession might have resulted in declines in trend output growth averaging about 3 percent for the advanced economies, but appear to have had little effect on emerging market trend growth.

Money growth and inflation: A regime switching approach

We develop a Markov Switching model for inflation with time-varying transition probabilities. Inflation is characterized by two regimes (high and low inflation) and the probability of regime changes depends on money growth. Using Bayesian techniques, we apply the model to the euro area, Germany, the US, the UK and Canada for data from the 1960s up to the present. Our estimates suggest that a smoothed measure of broad money growth, corrected for real-time estimates of trend velocity and potential output growth, has important leading indicator properties for switches between inflation regimes. Thus money growth provides an important early warning indicator for risks to price stability.

At a Glance …

Concurrent slowdown in every major economic region: world growth to slow to 3.3 per cent this year and 3.7 per cent next year.All major countries opt for the same policies of near zero interest rates and fiscal tightening.European countries face remarkably divergent growth paths next year: Germany above trend growth and Southern Europe in deep recession. Tensions will heighten further.World demand below potential output growth means rising unemployment — in some countries even higher than seen in the Great Depression.

Reprint of: The dollar and the current account deficit: How much should we worry?

The U.S. current account deficit is unsustainable and will need to fall by half as a share of GDP in coming years. The adjustment process will necessarily involve (1) substantial further real effective depreciation of the U.S. dollar, (2) slowing of U.S. demand growth below potential output growth, and (3) acceleration of demand growth relative to output growth in the rest of the world. Adjustment is likely to be reasonably orderly, with only modest risks of a “dollar crash”. Policy, including more aggressive fiscal consolidation in the U.S. and more rapid appreciation of key Asian currencies, can help assure orderly adjustment.

Dynamic Activity Analysis Model Based Win-Win Development Forecasting Under the Environmental Regulation in China

Porter Hypothesis states that environmental regulation may lead to win-win opportunities, that is, improve the productivity and reduce the undesirable output simultaneously. Based on directional distance function, this paper proposes a novel dynamic activity analysis model to forecast the possibilities of win-win development in Chinese Industry between 2009 and 2049. The evidence reveals that the appropriate energy-saving and emission-abating regulation will result in both the improvement in net growth of potential output and the steadily increasing growth of total factor productivity. This favors Porter Hypothesis.

The role of macroeconomic policies in the global crisis

This paper argues that the lack of timely and decisive policy action to correct domestic and external imbalances contributed crucially to the build-up of financial excesses that led to the financial crisis and the Great Recession. We focus on 2002–2007 and perform a number of counterfactual simulations to investigate two central elements of the story, namely: (a) an over-expansionary US monetary policy and the absence of effective macro-prudential supervision, which permitted a prolonged expansion of debt-financed consumer spending and (b) the choice by China and other emerging countries to pursue an export-led growth strategy supported by pegging their currencies to the US dollar, in conjunction with sluggish domestic demand in major advanced economies characterized by low potential output growth. The results of the simulations lend support to the view that if substantial, globally coordinated demand rebalancing had been undertaken early on, the macroeconomic and financial imbalances would not have accumulated to the extent that they did and the financial turmoil might have had less drastic global consequences.

Growth accounting for the euro area

This article is concerned with the estimation of euro area potential output growth and its decomposition according to the sources of growth. The growth accounting exercise is based on a multivariate structural time series model which combines the decomposition of total output according to the production function approach with price and wage equations that embody Phillips-type relationships linking inflation and nominal wage dynamics to the output gap and cyclical unemployment, respectively. Assuming a Cobb–Douglas technology with constant returns to scale, potential output results from the combination of the trend levels of total factor productivity (TFP) and factor inputs, capital and labour (hours worked), which is decomposed into labour intensity (average hours worked), the employment rate, the participation rate and population of working age. The nominal variables (prices and wages) play an essential role in defining the trend levels of the components of potential output, as the latter should pose no inflationary pressures on prices and wages. The structural model is further extended to allow for the estimation of potential output growth and the decomposition according to the sources of growth at different horizons (long run, medium run and short run); in particular, we propose and evaluate a model-based approach to the extraction of the low-pass component of potential output growth at different cut-off frequencies. The approach has two important advantages: the signal extraction filters have an automatic adaptation property at the boundaries of the sample period, so that the real-time estimates do not suffer from what is often referred to as the ‘end-of-sample bias’. Secondly, it is possible to assess the uncertainty of potential output growth estimates with different degrees of smoothness.

The Chilean Output Gap

This paper estimates the potential output (and the output gap) in Chile using several different methodologies. After a structural brake in 1998, the average growth rate of potential output in Chile declined from over 7 percent to 3-4 percent in the aggregate economy, but to less than 2 percent in the natural resource sector. The contributions to aggregate potential output growth of the natural resource sector and the non-natural resource sector are estimated, finding that the contribution to growth of the natural resource sector is non-linear-increasing during the 1990s, declining during the 2000s, and turning negative in the mid-2000s-despite the monotonic decrease in the share of natural resource output in aggregate output.