Potential output and output gaps against the backdrop of the COVID-19 pandemic

This section examines developments in potential output and output gaps across the euro area against the backdrop of the COVID-19 pandemic. Whilst mindful of the “normal” uncertainty which inevitably surrounds an unobservable variable such as potential output, it stresses that estimating potential has been especially challenging in the current crisis due to the complex mixture of supply, demand and liquidity shocks which COVID-19 provoked. In addition, standard business-cycle filtering methods are susceptible to producing excessively pro-cyclical potential output trends if key features of the COVID-19 crisis, such as labour hoarding and the underutilisation of physical capital, are not properly accounted for. Consequently, to handle the specificities of this unprecedented event, a number of stability-inducing methodological adjustments were made to the European Union’s Commonly Agreed Methodology (EUCAM) for the estimation of potential output and output gaps. In terms of results, the current Autumn 2021 EUCAM estimates for the euro area and its Member States do not show any persistent negative impact on potential output from COVID-19, in stark contrast with the global financial crisis and reflecting the different nature of the respective shocks (49). It should be noted that the potential implications of Russia’s invasion of Ukraine are completely excluded from the analysis since it is based on forecasts from last autumn.