New Output Gap Estimates for the Euro Area and Elsewhere

Output gaps (OG) identify economic cycles. A new simple method for estimating them is presented, giving results that are more transparent than those published by the leading economic policy institutions. The retroactive changes to the OGs as such do not indicate that they would have been incorrect. Instead, they depend on what happened afterwards, including changes in the policies implemented. After the Great Crunch of 2008-09, fiscal policy was tight, notably in 2011-13 in the euro area, contributing to an unexpected fall in GDP, which led to large retroactive corrections of the OG estimates for earlier years. A more nuanced interpretation is that the retroactive corrections stemmed from the unduly tight fiscal policy followed in 2011-13. The new OG estimates explicitly based on an assessment of the possible changes in the long-term growth prospects provide the rudiments for a fiscal policy that both rationally copes with short term disturbances and underlines the policy measures necessary for long-term sustainability. This could help to avoid pro-cyclicality of fiscal policy in the euro area in future.