Estimates of the potential growth rate of the Spanish economy

The potential growth of an economy is a key variable in economic analysis and economic policy decision-making, since it is the basic benchmark for assessing the cyclical position of the economy and for conducting a diagnosis of the macroeconomic policy stance. Potential output is defined as that level of production at which the economy can produce using available factors of production and existing technology without generating inflationary pressure. It can therefore be considered to describe how the supply side of an economy is working. Deviations of the observed production levels from the potential output tend to be related to the cyclical state of the economy, which in turn is influenced by demand conditions. This article updates the potential output estimates for the Spanish economy following the methodological changes to the National Accounts in 2005 – mainly concerning the change to base year 2000 – and to the Labour Force Survey (EPA) in the first quarter of the same year. A basic problem faced in analysis of potential output is that it is an unobservable variable, and estimates of it are subject to a relatively high degree of uncertainty. This article uses a methodology based on the estimation of a production function which is also used by various international institutions such as the OECD and the European Commission (EC). The main advantage of this technique is that it is based on a theoretical approach not found in other purely statistical methodologies which limit themselves to smoothing the original GDP series. The use of a methodology based on a production function also makes it possible to analyse the contribution of the various factors of production to economic growth. That said, its main drawback is that it requires highly diverse information and an appreciable number of simplifying assumptions, which, as mentioned above, means that estimates of potential output are subject to high uncertainty. From this standpoint, to obtain a more complete picture of the potential growth of an economy, it is preferable to analyse the results using averages for sufficiently long time periods and, if possible, to have a range of estimates obtained from the use of different procedures. The article is organised as follows: Section 2 describes succinctly the methodology used, Section 3 analyses the results obtained in terms of both potential growth and cyclical position, and Section 4 contains some brief final considerations.