Growth Beyond Imbalances. Sustainable Growth Rates and Output Gap Reassessment

Abstract

The Great Recession' was preceded by a prolonged period of high growth accompanied by low and stable inflation, the so called 'Great Moderation'. During that period, potential growth estimates were trending upwards and output gaps remained small. However, other imbalances were progressively accumulating, eventually bringing about the worst crisis in decades. Standard potential growth estimates, which consider inflation as the only indicator of macroeconomic imbalances, along with the stability of inflation in that period, therefore provided misleading signals to policymakers. This paper introduces a methodology to obtain sustainable growth rates, as an alternative measure to potential growth. Sustainable growth is defined as the output growth that does not generate or widen macroeconomic imbalances, identified through a wide set of domestic and external indicators. This allow us to reassess the behavior of output gaps in the US, the UK, Spain, Germany and China both in 'the Great Moderation' period and during 'the Great Recession'. In countries with large imbalances, sustainable growth rates are more stable than potential growth resulting in output gaps that were substantially larger in the period prior to the crisis.

Estimating Sustainable Output Growth in Emerging Market Economies

“…This closely links our work with the literature on the main factors explaining output fluctuations during the crisis of 2008 (Frankel and Saravelos, 2010;Lane and Milesi-Ferretti, 2011;Cecchetti et al, 2011;Feldkircher, 2014). Our main contribution to these strands of research is that we follow Alberola et al (2013), Borio et al (2013Borio et al ( , 2014 and Bernhofer et al (2014) in employing an empirical model that enables us to decompose output fluctuations into cycle and trend components based on the empirical relationships with various measures of imbalances. The resulting indicators may be interpreted, in an economic sense, as metrics of sustainable (ie not associated with the build-up of imbalances) output and the output gap.…”

“…Conveniently, in recent years there has been a significant number of contributions to the literature on such imbalances indicators. In fact, several international organizations have developed various frameworks for the evaluation and early detection of macroeconomic imbalances (see Alberola et al (2013) for a review). We follow these studies (most notably, Alessi and Detken (2011) and Frankel and Saravelos (2010)) in our choice of imbalances indicators, using those that have produced robust results under a variety of specifications of the model.…”

The Phillips Curve: (In)Stability, the Role of Credit, and Implications for Potential Output Measurement

“…As pointed out before, one reason for this may be the breakdown of the Phillips curve relationship during the last years. This has been recently emphasized by, for instance, Koop and Onorante (2012), ECB (2013), Alberola et al (2013), Coibion and Gorodnichenko (2013), and Ormerod et al (2013).…”

“…Moreover, the impact of a credit or financial cycle on potential output is documented by Bijapur (2012), Furceri and Mourougane (2012), Borio et al (2013b;a;2014), Benati (2013), Karfakis (2013), Alberola et al (2013). Moreover, Juselius and Juselius (2013) question the functioning of the Phillips curve during balance sheet recessions.…”

Growth and imbalances in Spain: a reassessment of the output gap

“…However, the crisis in Spain has shown that in that period observed growth was excessive and its nature pernicious for the stability of the system. This paper applies a new methodology to obtain estimates of sustainable growth rates for Spain (see also Alberola et al 2013). The sustainable growth rate is defined as the output growth that does not widen macroeconomic imbalances, which are identified through a wide set of domestic and external indicators (for alternative definitions, see, for example, Basu and Fernald 2009).…”