For Official Use ECO/CPE/WP1(2013)18 · ECO/CPE/WP1(2013)18 3 UNCERTAINTY ABOUT POTENTIAL OUTPUT...
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For Official Use ECO/CPE/WP1(2013)18 Organisation de Coopération et de Développement Économiques Organisation for Economic Co-operation and Development 30-Sep-2013 ___________________________________________________________________________________________ _____________ English - Or. English ECONOMICS DEPARTMENT ECONOMIC POLICY COMMITTEE Working Party No. 1 on Macroeconomic and Structural Policy Analysis UNCERTAINTY ABOUT POTENTIAL OUTPUT AND THE IMPLICATIONS FOR UNDERLYING FISCAL BALANCES This work is presented for comment by the Working Party before consideration of whether particular aspects should be pursued in greater detail and with a more comprehensive country coverage, with the possibility that they inform future methodological changes in the OECD's standard measures of potential output. In any case, the current work will be reported in forthcoming Working Papers. Contacts: Dave Turner, tel. (33-1) 45 24 87 15, fax: (33-1) 44 30 63 78, email: [email protected] JT03345242 Complete document available on OLIS in its original format This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area. ECO/CPE/WP1(2013)18 For Official Use English - Or. English
Transcript of For Official Use ECO/CPE/WP1(2013)18 · ECO/CPE/WP1(2013)18 3 UNCERTAINTY ABOUT POTENTIAL OUTPUT...
For Official Use ECO/CPE/WP1(2013)18 Organisation de Coopération et de Développement Économiques Organisation for Economic Co-operation and Development 30-Sep-2013
___________________________________________________________________________________________
_____________ English - Or. English ECONOMICS DEPARTMENT
ECONOMIC POLICY COMMITTEE
Working Party No. 1 on Macroeconomic and Structural Policy Analysis
UNCERTAINTY ABOUT POTENTIAL OUTPUT AND THE IMPLICATIONS FOR UNDERLYING
FISCAL BALANCES
This work is presented for comment by the Working Party before consideration of whether particular aspects
should be pursued in greater detail and with a more comprehensive country coverage, with the possibility that
they inform future methodological changes in the OECD's standard measures of potential output. In any case, the
current work will be reported in forthcoming Working Papers.
Contacts:
Dave Turner, tel. (33-1) 45 24 87 15, fax: (33-1) 44 30 63 78, email: [email protected]
JT03345242
Complete document available on OLIS in its original format
This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of
international frontiers and boundaries and to the name of any territory, city or area.
EC
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TABLE OF CONTENTS
UNCERTAINTY ABOUT POTENTIAL OUTPUT AND THE IMPLICATIONS FOR UNDERLYING
FISCAL BALANCES ................................................................................................................................ 3
Introduction ............................................................................................................................................ 4 Measurement issues related to potential output based on stable inflation ................................................. 5
Measurement issues related to the NAIRU .......................................................................................... 5 Measurement issues related to the capital stock ................................................................................. 10 Using survey measures of capacity utilisation as a check on output gaps ........................................... 13
Measures of sustainable output incorporating other macroeconomic imbalance indicators ..................... 15 Extending the estimation of finance neutral gaps to other countries and imbalance indicators ............ 17 The extent of revisions to real-time gap estimates .............................................................................. 21
Summary overview of alternative potential output measures ................................................................. 22 Implications for underlying fiscal balances ........................................................................................... 23
BIBLIOGRAPHY ................................................................................................................................... 26
Boxes
Main findings ......................................................................................................................................... 3 Box 1. Alternative methods for measuring sustainable output incorporating imbalance indicators ......... 17
Tables
1. Recent published estimates of the output gap for 2012 ..................................................................... 4
2. The significance of the unemployment gap term in estimated Phillips curves .................................... 6
3. Alternative estimates of the NAIRU for 2012 ................................................................................... 7
4. Alternative estimates of the output gap in 2012 using different methodologies ............................... 13
5. Alternative estimates of the 2012 underlying primary balance using different output gaps .............. 25
Figures
1. Alternative NAIRU estimates ........................................................................................................... 8
2. Estimated capital stock gaps ........................................................................................................... 11
3. Output gaps and capacity utilisation ............................................................................................... 14
4. Output gap estimates from Borio et al. (2013) and Alberola et al. (2013) ....................................... 16
5. OECD output gaps and finance neutral gaps compared ................................................................... 18
6. Real-time output gap revisions for the pre-crisis period .................................................................. 22
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UNCERTAINTY ABOUT POTENTIAL OUTPUT AND THE IMPLICATIONS FOR
UNDERLYING FISCAL BALANCES
Main findings
Differences in published output gap estimates are currently greatest for the European peripheral countries, with differences of between 3 and 6 percentage points for Ireland, Greece, Portugal and Spain, with published OECD estimates typically being more negative than those of the IMF or EC. This translates into uncertainty regarding the underlying primary balance of between 1½ and 3 percentage points of GDP. Alternative methods of calculating output gaps provide some suggestion that OECD output gaps in the European periphery could be exaggerated and so underlying fiscal positions correspondingly weaker.
Of various refinements to the OECD’s standard Phillip’s curve/Kalman filter approach to estimating the NAIRU, the most promising appears to be the incorporation of long-term unemployment into the estimation process. Revised NAIRU estimates better explain inflationary developments and are typically higher (especially for Ireland, Greece and Spain).
For gauging long-run fiscal sustainability, the use of a trend measure of capital stock is arguably more appropriate than the actual capital stock in measuring potential output. Using a simple Hodrick-Prescott filter to estimate the trend capital stock typically suggests much larger positive output gaps in the pre-crisis period (especially for countries of the European periphery). More recent differences are smaller, with still positive capital stock gaps for the European periphery (reducing the size of overall negative output gaps), but negative capital stock gaps for other countries (including the United States, Japan and Germany).
Survey measures of manufacturing capacity utilisation can be used as a cross-check on output gaps. However, differing degrees of fit between these variables across countries as well as mixed evidence regarding the usefulness of capacity utilisation in explaining revisions of real time output gaps, caution against the formal inclusion of capacity utilisation in measuring potential output in a mechanical way.
Attempts to measure alternative concepts of trend output suggest that for some countries (notably Ireland, Spain, United Kingdom and United States), where credit growth and housing have played an important role in recent cycles, using these variables as financial imbalance indicators to estimate sustainable output provides a plausible narrative of a more prolonged period of overheating in the pre-crisis period and large negative output gaps in the post-crisis period. In these cases, using such imbalance indicators also reduces revisions to real-time output gaps compared to those observed in published OECD estimates.
On the other hand, results for some other countries cast doubt on whether the methodology can be applied mechanically in the same way across all countries. In some cases, the imbalance indicators are not significant in explaining movements in GDP and, even when statistically significant, it may be inappropriate that imbalance indicators relating to the housing sector are used to anchor sustainable output in economies (such as Greece, Italy and Portugal) where housing does not usually play a dominant role in any explanation of the cycle. In most of these cases the robustness of pre-crisis gap estimates to revisions is little or no better than for published OECD output gaps. Experimentation with alternative imbalance indicators, as well as the form of the imbalance indicator, serves to emphasise the sensitivity of the results to this choice, particularly at the end-point.
For most countries, excluding those of the European periphery, variations in output gap estimates (whether from alternative methods or from other institutions) do not currently appear to imply much variation in the estimated underlying fiscal position, which are usually within 1 percentage point of GDP of OECD published estimates.
The CBO estimate of the output gap for the United States in 2012 is 2.7 percentage points more negative than the published OECD estimate (and also more negative compared to IMF estimates and variant output gap measures considered in this paper), although because of the lower US cyclical budget elasticity this only translates into a maximum difference in the underlying primary balance of 1 percentage point of GDP.
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Introduction
1. The usual uncertainty surrounding estimates of output gaps is currently compounded by the
difficulty of assessing the effect of the crisis on potential output. Such uncertainty is reflected in the
unusually wide range of recently published estimates of the output gap from different international and
national institutions (Table 1), with differences for some of the European periphery countries ranging
between 3 and 6½ percentage points. At the same time, estimates of the output gap ought to play an
important role in fiscal policy by distinguishing cyclical from underlying components of government
revenues and expenditure, especially given that a number of countries specify medium-term fiscal
objectives in terms of underlying or structural budget balances.
Table 1. Recent published estimates of the output gap for 2012
Percentage of potential output
Sources: OECD Economic Outlook no. 93, May 2013; IMF WEO database, April, 2013; European Commission, Spring 2013; United States: Congressional Budget Office, January 2013; Japan: Cabinet Office, August 2013; Italy: Ministry of Finance, April 2013; United Kingdom: Office for Budget Responsibility, March 2013; France: Ministry of Economy and Finance, April 2013; Germany: Ministry of Finance, April 2013; Ireland: Irish Department of Finance, April 2013; Spain: Ministry of Finance, April 2013; Canada: Bank of Canada, July 2013.
2. Complementing previous OECD work on the subject (Koske and Pain, 2008; Bouis et al., 2011),
this note considers some of the reasons for the uncertainty surrounding output gaps, distinguishing issues
related to the measurement and the underlying concept of potential output. While the usual concept
underlying measures of potential output is the level of output consistent with stable inflation, alternative
concepts of trend output consistent with avoiding the build-up of broader macroeconomic or financial
imbalances are also considered. The empirical exercises focus on a limited set of OECD countries, namely
the largest seven OECD countries and those of the European periphery (Greece, Ireland, Portugal and
Spain), which include most OECD countries where output gaps are believed to be large or fiscal
consolidation requirements are large. Finally, the implications of uncertainty about current output gaps for
measures of the underlying primary fiscal balances are assessed.
OECD IMF ECNational
institution
Maximum
difference
Canada -0.4 -1.1 -0.6 0.7
France -2.4 -3.1 -2.4 -2.0 1.1
Germany 0.1 0.1 0.0 -0.2 0.3
Greece -11.7 -7.7 -12.2 4.5
Ireland -7.9 -1.8 -1.3 -1.5 6.6
Italy -4.5 -3.4 -3.1 -3.6 1.4
Japan -0.8 -2.1 -2.4 1.6
Portugal -6.7 -3.9 -3.5 3.2
Spain -7.7 -4.5 -4.6 -7.7 3.2
United Kingdom -2.1 -3.0 -2.5 -2.7 0.9
United States -3.0 -4.3 -5.7 2.7
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Measurement issues related to potential output based on stable inflation
3. A practical problem with the standard concept of potential output is that inflation appears to have
been less sensitive to demand conditions over the last decade or so than it was previously, the well-
documented “flattening of the Phillips curve” (Koske and Pain, 2008), and hence by implication inflation is
a less reliable guide to the magnitude of any output gap.1 Relatedly, it is difficult to know whether the
limited degree of disinflation in a number of countries with large estimated output gaps is further evidence
of this phenomena or alternatively of potential output being much lower than currently estimated.
Measurement issues related to the NAIRU
4. In the OECD production function approach to identifying potential output and the output gap
(Johannson et al, 2012), information on inflation is incorporated into the estimation of a NAIRU
component embedded in a conventional Phillips curve (Guichard and Rusticelli, 2011) using a Kalman
filter. The reduced sensitivity of inflation to unemployment is confirmed by re-estimating the OECD
Phillips curve over sub-samples; for all countries examined the coefficient on the unemployment gap was
smaller and statistically less significant (and in most countries either statistically insignificant at the 10%
level or only barely significant) over a sample period beginning in 2000 compared with earlier sub-periods.
A number of approaches to improving the significance of the unemployment gap term have been
attempted, as described below, but with mixed success.
Incorporating the inflation target in the Phillips curve specification
5. One common explanation as to why inflation may be less sensitive to unemployment is that
inflation expectations have become better anchored due to the successful adoption of inflation targeting by
central banks. To address the effect of such a structural break, a term representing the central bank’s
implicit or explicit inflation target is sometimes included in the Phillips curve specification over the period
in which inflation targeting has been in operation (for example, Moccero et al., 2011). When this was
attempted for the sample of countries addressed in this paper, although in some cases the inflation target
term was statistically significant, its inclusion did little to change the point estimate of the NAIRU or to
improve the statistical significance of the unemployment gap (see Guichard and Rusticelli, 2011 and
Rusticelli et al., forthcoming).
Incorporating long-term unemployment in estimates of the NAIRU
6. A difficulty in estimating the NAIRU for recent years is that the smoothness parameters
underlying filtering methods, which may be appropriate in ‘normal’ times, may be too restrictive when
there are large and rapid changes in unemployment. In the post-crisis period, this could lead to the under-
estimation of the NAIRU and contribute to explaining the reduced statistical significance of unemployment
gaps in explaining inflation.2 To counter this problem a measure of long-term unemployment, capturing
possible hysteresis effects as skills are degraded, is included in the estimation procedure to allow greater
variability of the NAIRU at times when long-term unemployment is changing more rapidly. This
1. Various explanations for this, which are not necessarily mutually exclusive, include the consequences of
globalisation, the effect of greater credibility in monetary policy (discussed further below) and downwards
nominal rigidities at low rates of inflation.
2. This can only be a partial explanation, as the reduced significance of gap terms in explaining inflation is a
well-documented effect over the pre-crisis period.
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effectively pushes the estimate of the NAIRU in the direction of changes in long-term unemployment.
Formally this is achieved by including long-term unemployment in the Kalman filter transition equation
for the NAIRU (see Annex 1.1 for further details). For most countries the effect of including long-term
unemployment increases the size and statistical significance of the coefficient on the unemployment gap as
well as increases recent estimates of the NAIRU (Tables 2 and 3 and Figure 1). The effect is most striking
for Ireland, Greece and Spain where the estimate of the 2012 NAIRU is increased by between 2.3 and
2.8 percentage points. The implications these revised estimates have for the overall output gap published in
the last Economic Outlook is shown in column 2 of Table 4, where the revision to the NAIRU incorporates
both a change due to an update of the existing procedure and the change to the procedure to incorporate the
effect of long-term unemployment.3
Table 2. The significance of the unemployment gap term in estimated Phillips curves
Notes: The table reports the size and statistical significance of the coefficients on the unemployment gap term in the Phillips curve equation used to derive the OECD’s estimate of the NAIRU. The first column reports the results from estimating the standard Phillips curve specification described in Guichard and Rusticelli (2011) on an up-to-date sample and the second column the results from including the long-term unemployment rate (LTU) in the transition equation for the NAIRU. Statistical significance at the 1%, 5% and 10% significance levels is denoted by “***”, “**”and “*, respectively.
3. The effect on the overall output gap is calculated assuming other components of the production function
(total factor productivity, capital stock, labour force participation, etc.) remain unchanged and only
potential employment changes as a result of the change in the NAIRU.
Standard approach New approach
Canada -0.116*** -0.125***
France -0.084*** -0.127***
Germany -0.054** -0.074**
Greece -0.035 -0.055**
Ireland -0.014 -0.022*
Italy -0.022* -0.048**
Japan -0.176* -0.193**
Portugal -0.059* -0.056
Spain -0.017 -0.046**
United Kingdom -0.098** -0.130***
United States -0.031*** -0.035***
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Table 3. Alternative estimates of the NAIRU for 2012
Percentage of potential output
Note: The ‘standard OECD approach’ uses a Kalman filter within a Philips curve framework to estimate the NAIRU, as described in
Guichard and Rusticelli (2011). The ‘New approach’ considers the inclusion of long-term unemployment as described in Annex 1.1. For Germany, the revision in the NAIRU estimate relative to EO93 is mostly accounted for by a revised definition of unemployment.
Economic
Outlook 93
Update of the
standard
approach
New
approach
Canada 7.4 7.3 7.3 6.1
France 9.1 9.4 9.6 9.9
Germany 6.7 7.0 6.3 5.5
Greece 13.3 13.4 15.9 24.2
Ireland 10.5 9.8 10.6 14.7
Italy 8.6 8.4 8.7 10.6
Japan 4.3 4.3 4.4 4.3
Portugal 10.7 11.4 13.3 15.6
Spain 18.1 20.8 23.2 25.0
United Kingdom 6.9 7.4 7.5 7.9
United States 6.1 6.6 6.9 8.1
NAIRUActual
unemployment
rate
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Figure 1. Alternative NAIRU estimates
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Figure 1. Alternative NAIRU estimates (cont’d)
Note: The ‘standard OECD approach’ uses a Kalman filter within a Philips curve framework to estimate the NAIRU, as described in Guichard and Rusticelli (2011). The “New approach” includes long-term unemployment in the Kalman filter estimation as described in Annex 1.1. For Germany, the revision in the NAIRU estimate relative to EO93 is mostly accounted for by a revised definition of unemployment.
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Using alternative measures of inflation
7. Attempts to use alternative measures of inflation as the dependent variable in the Phillips curve,
such as measures of wage inflation or unit labour costs, were generally found to be less successful in
generating statistically significant unemployment gaps than using core measures of CPI inflation and so
these results are not reported further here.4
Measurement issues related to the capital stock
8. In the immediate aftermath of the crisis, because of uncertainty about the long-run effect of the
crisis on the capital stock, the OECD method of calculating potential output switched to using a measure of
the actual capital stock rather than a smoothed version of the series, thereby eliminating a cyclical capital-
stock component to the output gap (OECD, 2009). The revised approach corresponds to a short- or
medium-term concept of the output gap which may be better suited to monetary policy analysis (because
inflationary pressures are more directly related to the intensity of utilisation of existing capacity) whereas,
arguably, the previous long-term orientation may be more relevant to the assessment of fiscal policy which
is typically concerned with longer periods over which the capital stock might be expected to adjust. In the
context of assessing fiscal sustainability, a positive capital stock gap (i.e. capital stock in excess of the
trend) would tend to further boost an existing positive output gap or, equivalently, lower potential output.
9. The magnitude of this effect can be gauged by taking the difference between the actual and
filtered capital stock (where the filter is also applied to a projected capital stock to mitigate end-point
problems) as a measure of the “capital stock gap”. Such gaps are largest in the immediate pre-crisis period
(Figure 2); estimated excess capital stock for the euro area periphery countries is between 2 and
5 percentage points, and for other OECD countries is typically in the range of ½ to 1½ percentage points
(with the United States and United Kingdom being at the upper end of this range). Estimates of the capital
stock gap for 2012 are smaller; for the euro area periphery, despite post-crisis adjustment, there is still
excess capital of between 1½ and 3 percentage points; for other OECD countries the capital stock gaps are
much smaller and in some cases slightly negative (United States, Germany and Japan), implying most of
the adjustment to the trend has already taken place or is complete. Adjusting OECD output gaps for 2012
to incorporate these capital stock gaps,5 would imply that (negative) output gaps are 0.8 to 1.0 percentage
points smaller (i.e. correspondingly lower potential output) for Greece, Ireland, Portugal and Spain,
0.5 percentage points smaller for Italy, but for most other countries the difference would only be 0.1 to
0.2 percentage points or less, and in some cases (United States, Germany and Japan) would widen the
output gap (i.e. raise potential output) (Table 4, column 3).
4. Previous work (Guichard and Rusticelli, 2011) has found a relationship between changes in relative unit
labour costs and the unemployment gap for some euro area countries. Given the importance of relative unit
labour costs as a measure of imbalances within the euro area, this raises the possibility of calculating a path
for future unemployment which would not only stabilise relative unit labour costs but restore them to a
specific target over a particular horizon (for example, that prevailing at the start of monetary union). For
some countries, such as Italy, this would likely imply a much higher path for future unemployment than
that implied by conventional NAIRU estimates. However, because such calculations imply a very different
concept of equilibrium unemployment to the NAIRU and because they would require difficult assumptions
about the path of unit labour costs in trading partners, they have not been pursued here.
5. This adds the capital stock gap to the estimated output gap by applying the weight that capital is given in
the aggregate production function used to construct potential output.
ECO/CPE/WP1(2013)18
11
Figure 2. Estimated capital stock gaps
In percentage points deviation from trend
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Canada
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
France
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Greece
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Ireland
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Italy
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Germany
ECO/CPE/WP1(2013)18
12
Figure 2. Estimated capital stock gaps (cont’d)
In percentage points deviation from trend
Note: The trend is measured using an HP filter on actual and projected capital stock.
Source: Economic Outlook 93 database.
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
United Kingdom
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Japan
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Portugal
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
United States
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
Spain
ECO/CPE/WP1(2013)18
13
Table 4. Alternative estimates of the output gap in 2012 using different methodologies
As a percentage of potential output
(1) Output gaps derived from a production function approach and published in OECD Economic Outlook No. 93.
(2) Output gaps in (1) updated using long-term unemployment (LTU) to estimate the unemployment gap.
(3) Output gaps in (1) updated to include a “capital stock gap”.
(4) Output gaps in (1) updated to include both the adjustments in (2) and (3).
(5) Finance-neutral gaps as estimated by the OECD, calculated using the methodology outlined in Borio et al. (2013) as described further in Annex 1.3.
(6) Proxy for the output gap based on capacity utilisation, reported only for countries where a statistically significant link between capacity utilisation and the output gap was found on a pre-crisis sample, (“nc” denotes not calculated).
Using survey measures of capacity utilisation as a check on output gaps
10. Given the uncertainty about post-crisis output gaps, it may be informative to use other related
indicators as a cross-check. An obvious candidate for this purpose is business survey measures of capacity
utilisation given their conceptual similarity as well as the advantages they have of timeliness and absence
of revision.6 For most, but not all, OECD countries there is a significant positive correlation between (de-
trended) capacity utilisation and OECD output gaps over a pre-crisis sample (Koske and Pain, 2008)
(Figure 3).
6. On the other hand, the sectoral coverage of survey measures of capacity utilisation is usually limited to the
manufacturing sector only.
(1) (2) (3) (4) (5) (6)
OECDOECD + LTU
NAIRU update
OECD
+ capital gap
OECD
+ NAIRU update
+ capital gap
Finance-neutral
output gap
Based on
capacity
utilisation
Canada -0.4 -0.5 -0.4 -0.5 2.0 -3.0
France -2.4 -2.1 -2.2 -1.9 -0.9 nc
Germany 0.1 -0.1 0.0 -0.2 2.7 -0.6
Greece -11.7 -9.7 -10.7 -8.7 -5.3 nc
Ireland -7.9 -7.8 -7.0 -6.9 -5.9 nc
Italy -4.5 -4.4 -4.0 -3.9 -2.2 -3.2
Japan -0.8 -0.7 -1.0 -0.9 -2.2 0.4
Portugal -6.7 -4.7 -5.9 -3.9 -0.9 -7.0
Spain -7.7 -3.4 -6.9 -2.6 -4.7 -5.8
United Kingdom -2.1 -1.6 -2.1 -1.7 -3.4 nc
United States -3.0 -2.5 -3.2 -2.6 -4.3 nc
ECO/CPE/WP1(2013)18
14
Figure 3. Output gaps and capacity utilisation
In per cent of potential GDP and per cent of total capacity as a deviation from the sample average
Note: An “*” denotes countries where the relationship between the level of the output gap and the level of capacity utilisation was statistically significant over the pre-crisis period. The left hand axis represents the output gap, whereas the right hand axis represents capacity utilisation.
Source: Economic Outlook No. 93, OECD data from manufacturing surveys.
11. For current purposes, recent readings of capacity utilisation are used to generate an alternative
estimate of the 2012 output gap based on the predictions of an error correction regression between output
gaps and capacity utilisation on a pre-crisis sample estimation period. However, a stable long-run error-
correction relationship between the level of capacity utilisation and level of the output gap was only found
for just over half of the countries considered here (Canada, Germany, Italy, Japan, Portugal and Spain)
over the pre-crisis sample (see Annex 1.2 for detailed results). For these countries, the extent and direction
of the divergence in the derived output gap from published OECD measures differs (Table 4, column 6):
- 20
- 15
- 10
- 5
0
5
10
- 20
- 15
- 10
- 5
0
5
101
986
198
71
988
198
91
990
199
11
992
199
31
994
199
51
996
199
71
998
199
92
000
200
12
002
200
32
004
200
52
006
200
72
008
200
92
010
201
12
012
Greece
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
198
61
987
198
81
989
199
01
991
199
21
993
199
41
995
199
61
997
199
81
999
200
02
001
200
22
003
200
42
005
200
62
007
200
82
009
201
02
011
201
2
Spain*
- 14- 12- 10- 8- 6- 4- 2 0 2 4 6 8
- 14- 12- 10- 8- 6- 4- 2 0 2 4 6 8
198
61
987
198
81
989
199
01
991
199
21
993
199
41
995
199
61
997
199
81
999
200
02
001
200
22
003
200
42
005
200
62
007
200
82
009
201
02
011
201
2
Portugal*
- 14
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
- 14
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
198
6
198
7
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
Italy*
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
198
6
198
7
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
United Kingdom
- 14
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
- 14
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
198
61
987
198
81
989
199
01
991
199
21
993
199
41
995
199
61
997
199
81
999
200
02
001
200
22
003
200
42
005
200
62
007
200
82
009
201
02
011
201
2United States
- 14
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
- 14
- 12
- 10
- 8
- 6
- 4
- 2
0
2
4
6
198
6
198
7
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
France
- 26
- 16
- 6
4
14
24
- 26
- 16
- 6
4
14
24
198
61
987
198
81
989
199
01
991
199
21
993
199
41
995
199
61
997
199
81
999
200
02
001
200
22
003
200
42
005
200
62
007
200
82
009
201
02
011
201
2
Japan*
- 16- 14- 12- 10- 8- 6- 4- 2 0 2 4 6
- 16- 14- 12- 10- 8- 6- 4- 2 0 2 4 6
198
6
198
7
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
Germany*
Output gap Capacity utilisation
60 65 70 75 80 85 90 95 100
- 6- 4- 2 0 2 4 6 8
Output gap Capacity utilisation
-14-12-10-8-6-4-202468
-14-12-10-8-6-4-202468
198
6
198
7
198
8
198
9
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
Canada*
ECO/CPE/WP1(2013)18
15
for Italy and Spain the magnitude of the output gap in 2012 is reduced by about 1 and 2 percentage points,
respectively; for Portugal the difference is relatively small; for Japan it implies a small positive gap,
whereas the published OECD gap is small and negative; and for Germany it implies a small negative gap
compared to the small positive published OECD gap.
12. A further step, although not attempted here, is to integrate survey measures of capacity utilisation
into a production function methodology to estimate output gaps. In particular, the European Commission
use capacity utilisation to measure trend total factor productivity (tfp) in their production function
methodology used to generate output gaps, arguing that it reduces both total estimation error and the
revisions to real-time estimates of the concurrent tfp cycle compared to a univariate decomposition (Planas
et al., 2013). Given that for most countries the largest component of OECD measures of post-crisis output
gaps is the deviation of tfp from trend (Bouis et al., 2012),7 for many countries using additional
information to anchor the filtering process of trend tfp may be more important than better identifying the
NAIRU. On the other hand, the lack of any well determined statistical relationship between existing
measures of the output gap and capacity utilisation for over half of the countries considered (a result which
is confirmed when looking at the fit between tfp gaps and capacity utilisation) give some grounds for
caution before mechanically incorporating measures of capacity utilisation into any procedure for
estimating potential output. Moreover, contemporaneous measures of capacity utilisation only help to
explain subsequent revisions to real time OECD published estimates of the output gap in a minority of
countries.8,9
Measures of sustainable output incorporating other macroeconomic imbalance indicators
13. Recent work (Borio et al., 2013; Alberola, et al., 2013) has argued that the conceptual basis for
identifying potential output only through stable inflation is too restrictive, because, as illustrated during the
run-up to the recent crisis, low and reasonably stable inflation can co-exist with the build-up of financial
and other macroeconomic imbalances which mean that output is unsustainable.
14. A comparison of the estimates from Borio et al. (2013) and Alberola et al. (2013) is instructive in
highlighting that, even while the rationale behind the two approaches may be similar, the results can be
strikingly different because of the different methodologies adopted (Box 1), including which
macroeconomic imbalance variables are used. Comparisons here focus on the countries which are common
to both papers (Spain, United Kingdom and the United States), over the immediate pre-crisis period and
most recent year available (which in both cases is 2011), see Figure 4:10
7. Important exceptions are the United States, Spain, Greece and Portugal for which potential employment
gaps, mostly explained by unemployment gaps, account for most of the output gap.
8. For this purpose the initial real-time estimate of the output gap for year ‘t’ is taken as the published
estimate of the output gap appearing in the Spring edition of the OECD Economic Outlook in the following
year ‘t+1’. Regression analysis is then used to examine how well the latest published estimates of the
output gap for year t are explained by the real-time estimate and capacity utilisation for the same year. For
further details see Annex 1.2.
9. The result that capacity utilisation does not help to explain revisions to real-time output gap estimates was
also found in previous OECD research for the largest seven OECD economies over an earlier sample
period (Koske and Pain, 2008), although Graf and Sturm (2010) find contrary results.
10. For comparison purposes, figures quoted in the text and shown in Figure 4 are annual, because while Borio
et al. (2013) calculate quarterly measures of the gap, Alberola et al. (2013) only calculate annual measures.
ECO/CPE/WP1(2013)18
16
Figure 4. Output gap estimates from Borio et al. (2013) and Alberola et al. (2013)
In per cent of potential GDP
-8
-6
-4
-2
0
2
4
6
-8
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
United States
-8
-6
-4
-2
0
2
4
6
-8
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Spain
-8
-6
-4
-2
0
2
4
6
-8
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
United Kingdom
Borio et al. (2013) Alberola et al. (2013)
ECO/CPE/WP1(2013)18
17
For the United States, estimates of the immediate pre-crisis positive gaps are broadly similar,
however estimates for 2011 differ more substantially at -5.0 and -1.3 percentage points, from
Borio et al. and Alberola et al., respectively (the latest published OECD production function
estimate for 2011 being roughly in the middle);
For the United Kingdom the pre-crisis positive output gaps are larger according to Alberola et al.
at 5.0 percentage points compared to 2.6 from Borio et al., but estimates for 2011 are much
closer;
For Spain, both estimates imply a large pre-crisis positive output gap (both larger than the
published OECD gaps), but for 2011 there is a substantial difference with the Borio et al.
estimate of only -0.8 percentage points compared with -4.2 from Alberola et al. (and an even
larger published OECD gap of -5.9 for 2011).
Box 1. Alternative methods for measuring sustainable output incorporating imbalance indicators
The motivation for two recent papers (Borio et al., 2013; Alberola, et al., 2013) has been to derive measures of
sustainable output which use a broader set of macroeconomic imbalance indicators than just inflation, however, as described below, the methodologies adopted differ in a number of important respects.
Borio et al. (2013) describe their method as “trying to capture the information content that financial factors have for the cyclical, potentially highly persistent, variations in output and filter such movements out to obtain estimates of sustainable output”. This is achieved by initially setting up a standard Hodrick-Prescott filter in state-space form to filter GDP and then adding financial variables to the observation equation and using a Kalman filter to derive new estimates of what are referred to as “finance-neutral” output gaps. The variances of the estimation equations are chosen so that the variability of the resulting potential output is similar to what would be obtained with an HP filter with a lambda equal to1600. They initially use three financial variables as imbalance indicators, namely private credit market growth, real house prices and real interest rates (although the latter were not found to be significant and subsequently excluded from their preferred specification). The analysis is applied to the United States, United Kingdom and Spain.
Alberola et al. (2013) separately identify the “sustainable” part of each component of an aggregate production function (average hours worked, unemployment, labour force participation, productive and housing capital and tfp) rather than applying the estimation method to aggregate GDP. They use a wider selection of external and internal imbalance indicators, relating to the behaviour of prices (inflation, real effective exchange rate), savings and investment flows (the current account, private and public financial balances, components of savings and investment) and debt stocks (net foreign assets, private and public debt). For every imbalance indicator chosen a so-called “sustainable” component of the factor of the production function is estimated, and then aggregated by means of a multivariate approach which takes into account the root mean square error associated with each estimate. In doing so, the co-movement across all “sustainable” alternatives of the same factor of production is incorporated into the final estimate of the “sustainable” measure of growth. The authors claim that the outcome is largely independent of the aggregation methodology adopted and that final sustainable growth estimates are not correlated with the set of imbalances indicators. The analysis is applied to China, Germany, Spain, United Kingdom and United States.
Extending the estimation of finance neutral gaps to other countries and imbalance indicators
15. For the purposes of this paper, the methodology described in Borio et al. (op cit) is applied to a
broader range of countries to calculate finance-neutral output gaps. Estimations are carried out using the
same measures of financial imbalances, namely growth in real private credit, real house prices, and real
short-term interest rates, supplemented in a few cases with the share of housing investment in GDP as an
additional imbalance indicator for the housing market (see Annex 1.3 and Bagnoli et al., forthcoming, for
further details).11
Moreover, differently from Borio et al. findings, real short-term interest rates resulted in
11. In each case the financial imbalance indicator is expressed as a deviation from its historical average.
ECO/CPE/WP1(2013)18
18
significantly contribute to explain changes in the output gap for few countries. While difficult to generalise
the results (Figure 5) across all countries considered, a number of findings appear to apply to groups of
countries, as follows.
Figure 5. OECD output gaps and finance neutral gaps compared
In per cent of potential GDP
-8
-6
-4
-2
0
2
4
6
-8
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
United States
-6
-4
-2
0
2
4
6
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
United Kingdom
-10
-8
-6
-4
-2
0
2
4
6
8
-10
-8
-6
-4
-2
0
2
4
6
8
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Spain
EO93 OECD Finance-neutral Borio et al (2013)
-20
-15
-10
-5
0
5
10
-20
-15
-10
-5
0
5
10
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Greece
-10
-8
-6
-4
-2
0
2
4
6
8
-10
-8
-6
-4
-2
0
2
4
6
8
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Portugal
-6
-4
-2
0
2
4
6
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
I taly
ECO/CPE/WP1(2013)18
19
Figure 5. OECD output gaps and finance neutral gaps compared (cont’d)
In per cent of potential GDP
Note: “EO93” are the output gaps published in Economic Outlook No. 93; “OECD finance gaps” are those estimated by the OECD broadly following the methodology of Borio et al. (2013) with further details in Annex 1.3; “Borio et al. (2013)” are the finance-neutral gaps described in that publication (for Spain, United Kingdom and United States only).
Source: OECD.
-6
-4
-2
0
2
4
6
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
France
-6
-4
-2
0
2
4
6
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Germany
-15
-10
-5
0
5
10
15
-15
-10
-5
0
5
10
15
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Ireland
-10
-8
-6
-4
-2
0
2
4
6
8
10
-10
-8
-6
-4
-2
0
2
4
6
8
10
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Japan
-6
-4
-2
0
2
4
6
-6
-4
-2
0
2
4
6
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Canada
EO93 OECD Finance-neutral
ECO/CPE/WP1(2013)18
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Among most of the countries where both real house price growth and real credit growth are found
to be significant imbalance indicators (France, Spain, United Kingdom, and the United States)
over-heating in the pre-crisis period, as measured by sustained positive gaps over (at least) the
period 2000-07, tends to be greater than suggested by the OECD’s published output gap
measures. However, more recent readings of the finance-neutral gap differ in relation to OECD’s
published output gap measures depending on recent movements in the imbalance indicators:
For the United States and the United Kingdom, estimates of the finance-neutral gaps are 1¼
to 1½ percentage points more negative than OECD published output gaps for 2012, given that
the imbalance indicators (real credit growth and real house price growth) remain depressed
relative to historical averages or only show very recent signs of recovery. For Spain, the
imbalance indicators also remain relatively depressed relative to historical averages, leading
to a large finance-neutral negative gap of -4.7 percentage points, although this is smaller than
the most recent published OECD estimate.
For Ireland, for which house prices and real interest rates were found to be significant
imbalance indicators, the estimation leads to a strikingly large pre-crisis positive output gap
reaching 9 percentage points, but one which is not very different from the published OECD
output gap. Estimates for 2012 suggest that the finance-neutral gap is large and negative, but
about 2 percentage point less than the published OECD output gap.
For Japan, where both real house price growth and real credit growth are again found to be
significant imbalance indicators, the resulting finance-neutral gaps imply more overheating
than OECD production function gaps in the late 1980s and early 1990s, but are more negative
since, and particularly during the pre-crisis 2000s. This example can, however, also be used
to illustrate the sensitivity of the gap estimates to the particular specification of the imbalance
indicators. If instead of being expressed as the deviation from the sample average (beginning
in 1986) the imbalance indicators are expressed as the deviation from a longer-run historical
average beginning in the 1970s, then estimates of the finance gap are shifted downwards on
average by 3 percentage points since 2000.
For France, where the imbalance indicators remain only moderately depressed relative to
historical averages, the estimate of the finance-neutral gap for 2012 is only -0.9 compared
with the OECD published estimate of -2.4 percentage points.
For some of the remaining countries, the results tend to raise some concerns about the plausibility
of the approach, with additional attempts to use alternative imbalance indicators typically raising
further questions about the sensitivity of the results.
For Germany, for which both significant imbalance indicators are related to the housing
sector, the boom in housing investment following re-unification implies a sustained large
positive finance-neutral gap over most of the 1990s, contrasting with the more balanced
production function estimates of the output gap. Moreover, real house price growth in excess
of historical averages over the last couple of years, implies a positive output gap of over
2½ percentage points in 2011-12, compared to more balanced OECD, IMF and EC estimates
of the output gap. Further attempts to use real interest rates as an additional imbalance
indicator (not shown in Figure 5), implied a further positive revision to the output gap which
implausibly exceeded 7-8 percentage points in recent years.
For Canada, low real interest rates combined with high house price growth in the pre-crisis
period, contribute to somewhat greater overheating than implied by the OECD production
ECO/CPE/WP1(2013)18
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function gap. More strikingly, but perhaps less plausibly, the absence of any major correction
to the housing market together with the very accommodative monetary policy in the
aftermath of the crisis, implies a positive finance-neutral gap of about 2 percentage points
since 2010, in contrast to the modest negative output gap implied by the OECD production
function methodology.
For Portugal, Italy and Greece the finance-neutral gaps are typically less pronounced in both
directions compared to the OECD production function gaps, implying gap estimates for 2012
which are much less negative. However, the key role which is being assigned to the housing
imbalance variable, particularly in anchoring the filtering process at the end-point, raises
concerns about the plausibility of the approach, particularly for economies where feedback
links from the housing market to demand (via such transmission mechanisms as mortgage
equity withdrawal) are generally recognised to be weak. Attempts to use the current account
balance (which features strongly in the work of Alberola et al. (2013)) as an additional
imbalance indicator for these countries tended to suggest that the gaps for 2012 were either
virtually closed or even positive. Further attempts to use relative unit labour costs (which
have often featured in the debate about imbalances within the euro area) were unsuccessful,
with the variable either statistically insignificant and/or wrongly signed.
16. Overall, a general impression from the limited exercise reported here, is that the estimates of the
alternative measures of sustainable output are sensitive to the choice and specification of the imbalance
indicators and that the appropriate imbalance indicators are likely to differ between countries. This in turn
emphasises that a degree of judgement is required in applying such methods, and also raises a problem that
it may only be clear with hindsight (i.e. after a major boom/bust episode) which are the most appropriate
imbalance indicators to use.
The extent of revisions to real-time gap estimates
17. The robustness of gap estimates is evaluated by comparing real-time and ex post estimates of
published OECD production function estimates of the output gap and OECD estimates of the finance-
neutral gap described above.12
The results show sizeable positive revisions between real time and ex post
measures of 2007 gaps under both methods (Figure 6), and although the revisions are generally notably
smaller for some countries with the finance-neutral gaps, the results are mixed:
The most spectacular difference is for Ireland, for which the revision of the pre-crisis output gap
has been from a real-time estimate of 0.6 percentage points to 8.8 percentage points now,
compared to a real-time estimate of the pre-crisis finance-neutral gap of 3.9 percentage points
which on most recent data would be estimated to be 7.7.
For Italy, Spain, United Kingdom and United States the ex-post revisions to the pre-crisis gaps
are about 1½ to 2 percentage points for the estimated finance-neutral gaps, but larger for the
published OECD output gaps by about 1 to 1½ percentage points. For Portugal, Greece, France,
Germany and Japan the differences in the scale of revisions across the two methods are much
smaller.
12. For this purpose, the data published in the autumn 2008 Economic Outlook (No. 84), has been used to
estimate real-time finance-neutral and HP-filter based output gaps up until the end of 2007, which have
then been compared to those estimated on the data published in the recent spring 2013 Economic Outlook
(No. 93).
ECO/CPE/WP1(2013)18
22
18. These results demonstrate that for those countries (Ireland, Spain, United Kingdom and United
States) where housing played a major role in the recent cycle using a housing variable as an imbalance
indicator helps to anchor estimates of the output gap, but for the other countries considered, the gains from
using imbalance indicators are much smaller.
Figure 6. Real-time output gap revisions for the pre-crisis period
In percentage points
Note: Revisions are computed as difference between the latest output gap estimates for 2007 Q4, using the database consistent with the most recent Economic Outlook (No. 93) and gap estimates for 2007 Q4 using the Economic Outlook (No. 84) database published in December 2008.
Source: OECD calculations.
Summary overview of alternative potential output measures
19. The sensitivity of measures of the output gap to different methodologies summarised in Table 4
raises the question as to whether the implied revisions can be regarded as ‘additive’ or whether they are
mutually exclusive ‘alternatives’. The output gap revisions resulting from re-estimations of the NAIRU
(column 2 in Table 4) and from using trend rather than actual capital stock (column 3 in Table 4), can be
considered as additive because they relate to separate components of the existing production function
approach to estimating potential output, as illustrated in column 4 of Table 4. This is of most relevance in
the case of the European periphery countries, for which both revisions are sizeable and both go in the
direction of reducing the size of negative output gaps estimated for 2012. The gap measures based on
finance-neutral sustainable output and capacity utilisation (columns 5 and 6 in Table 4, respectively) are
better considered as alternative measures, so that the implied revisions are not additive to other revisions.13
20. The variants to the existing production function approach as well methodologies to estimate
alternative concepts of sustainable output also raise the question as to which merit being examined in
13. If capacity utilisation was used in the estimation of tfp gaps, as for example is done by the European
Commission, then such an adjustment to the output gap could be additive to the NAIRU adjustment and
capital stock gap, but this is not what is reported in Table 4.
0
1
2
3
4
5
6
7
8
9
0
1
2
3
4
5
6
7
8
9
Ireland Greece United Kingdom Italy Spain France United States Portugal Germany Japan Canada
Production function based gap Finance-neutral gap
ECO/CPE/WP1(2013)18
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further detail, including through a wider country coverage, with a view to possibly incorporating them in
the OECD’s regular measures of potential output and output gaps. The preliminary view of the Secretariat
regarding the different methods is as follows:
Among variations to the OECD’s standard Phillips curve/Kalman filter approach to estimating
the NAIRU, the incorporation of long-term unemployment into the transition equation describing
the NAIRU appears the most promising. Firstly, this is because there is a well-established link in
the literature between structural and long-term unemployment, and secondly, among the sample
of countries considered here, it tends to improve the statistical fit of the unemployment gap in
explaining inflation.
A previous move to using the actual capital stock, rather than a smoothed measure, in the OECD
production function measure of potential output, took place at the onset of the crisis because of
the increased uncertainty about what would happen to the capital stock following such a large
shock. With the shock now in the past, it may be appropriate to consider a switch back to using a
smoothed measure of the capital stock. Such a change would also be appropriate if the main use
of the output gap measure was considered to be for assessing medium-term fiscal sustainability
rather than short-run inflationary pressure.
While there is an attraction to using survey measures of capacity utilisation to try to anchor
estimates of the output gap (or component gaps, such as the tfp gap), particularly at the end-point,
a range of simple tests appear disappointing in this regard. In particular, for a majority of
countries it is difficult to find any well-determined relationship between the output gap (or
component gaps) and capacity utilisation, even if the sample period is limited to the pre-crisis
period. Other results suggest that capacity utilisation is of limited use, and then only in a minority
of countries considered, in explaining real time revisions to published OECD output gaps. These
results appear to caution against trying to incorporate measures of capacity utilisation into the
production function methodology in any mechanical way for all OECD countries.
Alternative measures of sustainable output which incorporate financial imbalance indicators can,
for some countries, provide a plausible narrative of a more prolonged period of overheating in the
pre-crisis period and large negative output gaps in the post-crisis period. In some of these cases,
using such imbalance indicators reduces the extent of revisions to real-time output gaps
compared to those observed in published OECD estimates. On the other hand, results for other
countries cast doubt on whether the methodology can be applied mechanically in the same way
across all countries. For some countries, the financial imbalance indicators are not significant in
explaining movements in GDP, or alternatively they play a dominant role in determining the gap
which may be at odds with any usual explanation of the cycle for the country concerned. In many
of these cases the robustness of pre-crisis gap estimates to revisions is little or no better than for
published OECD output gaps. Experimentation with alternative imbalance indicators, as well as
the form of the imbalance indicator, serves to emphasise the sensitivity of the results to this
choice, particularly at the end-point. All in all, the results suggest that routinely producing such
measures for all OECD countries would be resource-intensive, particularly because it would
involve a large degree of customisation by country (particularly in the choice of imbalance
indicators), which in itself might limit the attractiveness of such measures.
Implications for underlying fiscal balances
21. The implications for the underlying primary balance of different output gap estimates can be
derived from applying an aggregate estimate of the overall sensitivity of fiscal balances to the output gap
using an aggregation of OECD estimated elasticities for individual tax and expenditure components
ECO/CPE/WP1(2013)18
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(Girouard and Andre, 2005). For a typical OECD country a 1 percentage point change in the output gap
will change the primary fiscal balance by around 0.5 percentage points of GDP, but by somewhat less for
countries such as Japan and the United States where taxes and government expenditure are a smaller share
of GDP (see the final column of Table 5). Using the range of output gap estimates discussed in this paper
the main implications regarding the uncertainty about current underlying fiscal positions are as follows
(Table 5):
For a majority of countries considered, but with the exception of countries of the European
periphy, variations in output gap estimates (whether from alternative methods or from other
institutions) do not currently appear to imply much variation in the estimated underlying fiscal
position, usually being less than 1 percentage point of GDP.
CBO estimates of the output gap for the United States in 2012 are 2.7 and 1.4 percentage points
more negative than OECD and IMF estimates, respectively, although because of the lower US
cyclical budget elasticity this only translates into a maximum difference in the underlying
primary balance of 1 percentage point of GDP.
Differences in published output gap estimates are currently greatest for the European periphery
countries, with differences of between 3 and 6 percentage points for Ireland, Greece, Portugal
and Spain, with OECD estimates typically being more negative than those of the IMF or EC. This
translates into uncertainty regarding the underlying primary balance of between 1½ and
3 percentage points of GDP. Alternative methods of calculating output gaps provide some
suggestion that OECD output gaps in the European periphery could be exaggerated and so
underlying fiscal positions correspondingly weaker.
Based on survey measures of capacity utilisation the output gap could be 1 and 2 percentage
points less negative in Italy and Spain, respectively;
Using long-term unemployment in the estimation of the NAIRU could lead to upward
revisions in the estimation of the NAIRU and hence reduce output gaps by between 2 and
4¼ percentage points for Greece, Portugal and Spain;
Adjusting OECD published output gaps for 2012 to incorporate capital stock gaps, would
reduce output gaps by 0.8 to 1.0 percentage points for Greece, Ireland, Portugal and Spain
and 0.5 percentage points for Italy;
Finally, finance-neutral estimates imply the output gap could currently be between 2 and
6 percentage points smaller for Greece, Ireland, Italy, Portugal and Spain, although, as
previously suggested, these estimates need to be interpreted with particular caution.
ECO/CPE/WP1(2013)18
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Table 5. Alternative estimates of the 2012 underlying primary balance using different output gaps
As a percentage of potential output
(1) Underlying primary balance published in OECD Economic Outlook No. 93.
(2)-(6) Underlying primary balances calculated as (1) plus the change in the output gap estimate (relative to EO93) implied by the corresponding entry in Table 4, multiplied by the budget elasticity in (7).
(7) Budget elasticities derived from Andre and Girouard (2005).
(1) (2) (3) (4) (5) (6) (7)
OECDOECD + LTU
NAIRU update
OECD
+ capital gap
OECD
+ NAIRU update
+ capital gap
Finance-neutral
output gap
Based on
capacity
utilisation
Memorandum:
cyclical budget
elasticity
Canada -2.5 -2.4 -2.5 -2.5 -3.4 -1.5 0.39
France -1.3 -1.5 -1.4 -1.5 -2.0 nc 0.45
Germany 1.6 1.7 1.6 1.7 0.5 1.9 0.42
Greece 0.3 -0.7 -0.2 -1.2 -2.9 nc 0.49
Ireland -1.2 -1.3 -1.7 -1.7 -2.2 nc 0.46
Italy 4.4 4.4 4.2 4.1 3.4 3.8 0.44
Japan -8.6 -8.7 -8.6 -8.6 -8.2 -9.0 0.30
Portugal 0.4 -0.4 0.1 -0.7 -1.8 0.5 0.38
Spain -4.3 -6.3 -4.6 -6.7 -5.7 -5.2 0.47
United Kingdom -2.8 -2.9 -2.8 -2.9 -2.2 nc 0.42
United States -5.5 -5.7 -5.5 -5.7 -5.1 nc 0.36
ECO/CPE/WP1(2013)18
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