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Rethinking potential output: Embedding information about the financial cycle

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

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References

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Citations

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
  2. Le talon d’Achille du système monétaire et financier international
    by ? in D'un champ l'autre on 2014-09-06 22:51:00
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Cited by:
  1. Boysen-Hogrefe, Jens, 2014. "Niedrige Zinsen und rasche monetäre Expansion: Was soll die Finanzpolitik tun?," Kiel Policy Brief, Kiel Institute for the World Economy (IfW) 75, Kiel Institute for the World Economy (IfW).
  2. Athanasios Orphanides, 2013. "Is monetary policy overburdened?," BIS Working Papers, Bank for International Settlements 435, Bank for International Settlements.
  3. 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), Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 52-75.
  4. Olmos, Lorena & Sanso Frago, Marcos, 2014. "Natural Rate of Interest with Endogenous Growth, Financial Frictions and Trend Inflation," MPRA Paper 57212, University Library of Munich, Germany.
  5. Bergin, Adele & FitzGerald, John, 2014. "The Structural Balance for Ireland," Quarterly Economic Commentary: Special Articles, Economic and Social Research Institute (ESRI), Economic and Social Research Institute (ESRI).
  6. Kurt Kratena & Mark Sommer, 2014. "Labour Market Policy and Environmental Fiscal Devaluation: A Cure for Spain in the Aftermath of the Great Recession?," WIFO Working Papers, WIFO 476, WIFO.
  7. Dorin Mantescu & Dan-Tudor Lazar, 2014. "Estimation of Potential GDP and output Gap. Comparative Perspective," The AMFITEATRU ECONOMIC journal, Academy of Economic Studies - Bucharest, Romania, Academy of Economic Studies - Bucharest, Romania, vol. 16(37), pages 951, August.
  8. Enrique Alberola & Ángel Estrada & Daniel Santabárbara, 2013. "Growth beyond imbalances. Sustainable growth rates and output gap reassessment," Banco de Espa�a Working Papers, Banco de Espa�a 1313, Banco de Espa�a.
  9. Christian Friedrich, 2014. "Global Inflation Dynamics in the Post-Crisis Period: What Explains the Twin Puzzle?," Working Papers, Bank of Canada 14-36, Bank of Canada.
  10. 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.

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