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Uncertainty surrounding output gap estimatesThe Belgian case

Igor Lebrun

Workshop on Potential Growth and Fiscal Challenges, Brussels, 27 October 2009

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Key stylized facts on output losses associated with financial crises (1)

IMF World Economic Outlook (Sept 2009):

Output does not recover to pre-crisis trend

Medium-term growth rates tend to return to the pre-crisis rate

The output loss results from reductions in roughly equal proportions in the employment rate, the capital-to-labour ratio and TFP

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Key stylized facts on output losses associated with financial crises (2)

But variation in outcomes across country experiences is substantial:

The higher the short-term output losses or the pre-crisis investment share the larger the medium-term output damage

Macroeconomic stimulus in the short run is associated with smaller medium-term output losses

A favorable external environment is also generally associated with smaller medium-term output losses

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The FPB’s medium-term spring scenario for Belgium is consistent with these stylized facts

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The FPB’s medium-term spring scenario for Belgium is consistent with these stylized facts

Output loss

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Two alternative scenarios with the same philosophy

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Potential GDP estimates in the baseline scenario using the EC method

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Potential GDP estimates in the baseline scenario using the EC method

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Decomposition of these revisions by production factor

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Revisions to TFP trend growth using the HP filter

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And to the NAIRU using the Kalman filter

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And to the NAIRU using the Kalman filter

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Revisions to the output gap

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Large ex post output gap revisions did happen in the past

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Large ex post output gap revisions did happen in the past

Revision

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Our potential growth estimates resemble those of the EC

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But differ fundamentally from those of the OECD

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Potential growth and contributions

2006-2008 2009-2010 2011-2017

OECD FPB OECD FPB OECD FPB

Potential GDP 2.5 1.8 1.8 1.2 1.0 1.6

Productivity 1.3 0.7 1.2 0.6 1.2 1.1

Employment 1.2 1.1 0.6 0.6 -0.2 0.6

Working age population

1.0 0.9 0.9 0.6 -0.1 0.3

Participation rate

0.2 0.2 0.1 0.2 0.1 0.2

NAIRU 0.0 0.0 -0.4 -0.2 -0.1 0.1

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With significant repercussions on the output gap estimates

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Behind technical differences, contrasting views of history?

Did we experience a “bust without a boom”?

If yes, potential output before the outbreak of the crisis should not be revised

If no, potential GDP has been overestimated in the years preceding the crisis, lulled by global disinflation

These two contrasting views have implications on the stance of monetary and fiscal policy before the crisis

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Implications for potential GDP computations

Has TFP (and employment) growth been temporarily boosted by the imbalances at the origin of the crisis?

The method of the Commission gives an implicit “yes” to the question

Or shall we solely take into account the consequences of the crisis on the supply-side conditions?

The approach adopted by the OECD responds with a more explicit “yes” by considering only the impact on the capital stock and the unemployment rate

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Both approaches have their merits and limits“Rules versus discretion”

EC method does not circumvent the problem of trend TFP and NAIRU levels before the crisis but:

Applying HP filter on Solow residuals may be too mechanical

Risk that Kalman filter generates too pro-cyclical structural unemployment rates

OECD method has more economic underpinning but:

Some effects may be lacking

Impact on output gap of switch from smoothed to actual capital services series not straightforward

NAIRU evolutions are only guided by hysteresis effects

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Conclusions (1)

Consensus among economists that the crisis is likely to have a permanent impact on the level of potential GDP.

But great uncertainty remains regarding:

The total amount of output loss

The specific impact on each of the production factors

And the precise path of the adjustment which is crucial for potential growth and output gap estimates

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Conclusions (2)

We should bear in mind that next to the impact of the crisis, potential GDP estimates are also influenced by other factors:

Demographic projections

Impact of macroeconomic policies

Expected effects of structural reforms

Estimating potential GDP and output gaps in real time remains in essence a forecasting exercise!

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