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Rethinking potential output: Embedding information about the financial cycle

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Author Info

  • Claudio Borio
  • Frank Piti Disyatat
  • Mikael Juselius

Abstract

This paper argues that incorporating information about the financial cycle is important to improve measures of potential output and output gaps. Conceptually, identifying potential output with non-inflationary output is too restrictive. Potential output is seen as sustainable; yet experience indicates that output may be on an unsustainable path even if inflation is low and stable whenever financial imbalances are building up. More generally, as long as potential output is identified with the non-cyclical component of output fluctuations and financial factors play a key role in explaining the cyclical part, ignoring these factors leaves out valuable information. Within a simple and transparent framework, we show that including information about the financial cycle can yield measures of potential output and output gaps that are not only estimated more precisely, but also much more robust in real time. In the context of policy applications, such "finance-neutral" output gaps are shown to yield more reliable estimates of cyclically adjusted budget balances and to serve as complementary guides for monetary policy.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 404.

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Length: 35 pages
Date of creation: Feb 2013
Date of revision:
Handle: RePEc:bis:biswps:404

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Related research

Keywords: Potential output; output gap; financial cycle; monetary policy; fiscal policy;

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References

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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Le rôle des banques centrales lors du cycle financier selon Claudio Borio
    by ? in D'un champ l'autre on 2014-02-17 16:58:00
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Cited by:
  1. Dominik Bernhofer & Octavio Fernández-Amador & Martin Gächter & Friedrich Sindermann, 2014. "Finance, Potential Output and the Business Cycle: Empirical Evidence from Selected Advanced and CESEE Economies," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 52-75.
  2. Harri Kemp, 2014. "Measuring potential output for the South African economy: Embedding information about the financial cycle," Working Papers 03/2014, Stellenbosch University, Department of Economics.
  3. Enrique Alberola & Ángel Estrada & Daniel Santabárbara, 2013. "Growth beyond imbalances. Sustainable growth rates and output gap reassessment," Banco de Espa�a Working Papers 1313, Banco de Espa�a.
  4. Boysen-Hogrefe, Jens, 2014. "Niedrige Zinsen und rasche monetäre Expansion: Was soll die Finanzpolitik tun?," Kiel Policy Brief 75, Kiel Institute for the World Economy (IfW).

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