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Potential Output and the Output Gap in Ireland

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  • Slevin, Geraldine

    (Central Bank and Financial Services Authority of Ireland)

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    Abstract

    The performance of the Irish economy in recent years has been outstanding. Between 1994 and 2000, Ireland’s economic growth, as measured by the annual percentage change in real GDP (Gross Domestic Product), has expanded at an annual average rate of approximately 9 per cent. Over the same time period, we have also experienced annual employment growth of approximately 5 per cent and capital growth of around 4 per cent. Recent developments would suggest that such advances cannot continue forever. The capacity of an economy depends on the quantities of labour, capital and technology. Over time that capacity will grow because of the movement of employment from low output industries to high output modern sectors and advances in productivity brought about by improvements in technology. An economy may for brief periods operate above capacity. This is unlikely to persist in the long-run, as there will tend to be a wage and price adjustment process which will restore equilibrium. The capacity of an economy is not measured directly and must be estimated using information from other economic aggregates, which can be measured. Several methods have been proposed but there is no general agreement as to which method is best. This paper applies several of these methods to estimate the capacity of the Irish economy over the period 1960 to 2000. A broad degree of agreement was found between the various methods. Since 1997 the economy has operated above capacity. Forecasts of the capacity growth rate were outlined using estimates from ESRI (1999) and internal Central Bank estimates. This suggests that economy will be operating below capacity by 2004, when a more sustainable level of output is achieved. The output gap is defined as the difference between actual and capacity output. A positive gap (output greater than capacity) is associated with excess demand in the economy, which is a likely cause of inflation. In an open economy, such as Ireland, it is often argued that the main determinants of inflation are foreign prices and the exchange rate. The measures of the output gap derived in this paper indicate that they have some influence on overall inflation in Ireland, but the results were relatively weak. The relationship between “domestically generated” inflation and the output gap measures indicated a much stronger correlation.

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    Bibliographic Info

    Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 5/RT/01.

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    Length: 30 pages
    Date of creation: Sep 2001
    Date of revision:
    Handle: RePEc:cbi:wpaper:5/rt/01

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    1. Duffy, David & FitzGerald, John & Kearney, Ide & Smyth, Diarmaid, 1999. "Medium-Term Review 1999-2005, No. 7," Forecasting Report, Economic and Social Research Institute (ESRI), number MTR07, September.
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    4. Jacques R. Artus, 1977. "Measures of Potential Output in Manufacturing for Eight Industrial Countries, 1955-78 (Estimation du potentiel de production relative au secteur manufacturier de huit pays industriels, 1955-78) (Medic," IMF Staff Papers, Palgrave Macmillan, vol. 24(1), pages 1-35, March.
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    7. Ben S. Bernanke & Refet S. Gurkaynak, 2001. "Is Growth Exogenous? Taking Mankiw, Romer and Weil Seriously," NBER Working Papers 8365, National Bureau of Economic Research, Inc.
    8. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
    9. Meyler, Aidan, 1999. "The non-accelerating inflation rate of unemployment (NAIRU) in a small open economy: The irish context," MPRA Paper 11363, University Library of Munich, Germany.
    10. Miguel Lebre de Freitas, 2000. "Quantity versus quality: the growth accounting in Ireland," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
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    13. Paula De Masi, 1997. "IMF Estimates of Potential Output," IMF Working Papers 97/177, International Monetary Fund.
    14. Kenny, Geoff, 1996. "Capacity Utilisation in Irish Manufacturing," Research Technical Papers 2/RT/96, Central Bank of Ireland.
    15. Raymond Torres & John P. Martin, 1989. "Potential Output in the Seven Major OECD Countries," OECD Economics Department Working Papers 66, OECD Publishing.
    16. W. Bolt & P.J.A. van Els, 2000. "Output Gap and Inflation in the EU," DNB Staff Reports (discontinued) 44, Netherlands Central Bank.
    17. John FitzGerald, 2001. "Wage Determination in Economies in Transition: Ireland Spain and Portugal," Papers WP141, Economic and Social Research Institute (ESRI).
    18. Paul Conway & Ben Hunt, 1997. "Estimating potential output: a semi-structural approach," Reserve Bank of New Zealand Discussion Paper Series G97/9, Reserve Bank of New Zealand.
    19. Fagan, Gabriel & Henry, Jérôme & Mestre, Ricardo, 2001. "An area-wide model (AWM) for the euro area," Working Paper Series 0042, European Central Bank.
    20. Fabiani, Silvia & Mestre, Ricardo, 2000. "Alternative measures of the NAIRU in the euro area: estimates and assessment," Working Paper Series 0017, European Central Bank.
    21. Aidan Meyler, 1998. "Technology and Foreign Direct Investment in Ireland," Economics Technical Papers 9810, Trinity College Dublin, Department of Economics.
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    Cited by:
    1. Angelica E. Njuguna & Stephen N. Karingi & Mwangi S. Kimenyi, 2005. "Measuring Potential Output and Output Gap and Macroeconomic Policy: The Case of Kenya," Working papers 2005-45, University of Connecticut, Department of Economics.
    2. Kieran McQuinn, 2005. "Dynamic Factor Demands in a Changing Economy - An Irish Application," The Economic and Social Review, Economic and Social Studies, vol. 36(2), pages 109-126.
    3. Jesús Antonio Bejarano Rojas, . "El Canal de Oferta Agregada en un Modelo de Mecanismos de Transmisión de la Política Monetaria en Colombia," Borradores de Economia 241, Banco de la Republica de Colombia.
    4. Slevin, Geraldine, 2002. "Is There a "New Economy" in Ireland?," Research Technical Papers 3/RT/02, Central Bank of Ireland.
    5. Michaelides, Panayotis & Milios, John, 2009. "TFP change, output gap and inflation in the Russian Federation (1994-2006)," Journal of Economics and Business, Elsevier, vol. 61(4), pages 339-352, July.
    6. Edward Nelson, 2006. "Ireland and Switzerland: the jagged edges of the Great Inflation," Working Papers 2006-016, Federal Reserve Bank of St. Louis.
    7. Mc Quinn, Kieran, 2003. "Alternative Models of the Irish Supply Side," Research Technical Papers 2/RT/03, Central Bank of Ireland.
    8. Mc Quinn, Kieran, 2003. "Dynamic Factor Demands in a Changing Economy: An Irish Application," Research Technical Papers 3/RT/03, Central Bank of Ireland.
    9. Jesús Antonio Bejarano Rojas, 2003. "El Canal De Oferta Agregada En Un Modelo De Mecanismos De Transmisión De La Política Monetaria En Colombia," BORRADORES DE ECONOMIA 002461, BANCO DE LA REPÚBLICA.
    10. Slevin, Geraldine, 2005. "Y a-t-il une nouvelle économie en Irlande?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 81(1), pages 111-142, Mars-Juin.
    11. Jorg Scheibe, 2003. "The Chinese Output Gap During the Reform Period 1978-2002," Economics Series Working Papers 179, University of Oxford, Department of Economics.

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