plan.be Uncertainty surrounding output gap estimates The Belgian case Igor Lebrun Workshop on Potential Growth and Fiscal Challenges, Brussels, 27 October 2009

plan.be 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

plan.be 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

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

plan.be Output loss

plan.be Two alternative scenarios with the same philosophy

plan.be Potential GDP estimates in the baseline scenario using the EC method

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plan.be Decomposition of these revisions by production factor

plan.be Revisions to TFP trend growth using the HP filter

plan.be And to the NAIRU using the Kalman filter

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plan.be Revisions to the output gap

plan.be Large ex post output gap revisions did happen in the past

plan.be Revision

plan.be Our potential growth estimates resemble those of the EC

plan.be But differ fundamentally from those of the OECD

plan.be Potential growth and contributions OECDFPBOECDFPBOECDFPB Potential GDP Productivity Employment Working age population Participation rate NAIRU

plan.be With significant repercussions on the output gap estimates

plan.be 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

plan.be 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

plan.be 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

plan.be 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

plan.be 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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