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Measuring potential output for the South African economy: Embedding information about the financial cycle

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  • Harri Kemp

    () (Bureau for Economic Research, university of Stellenbosch)

Abstract

In a recent paper, Borio et al (2013a) show that information embedded in the financial cycle can serve to improve measures of potential output and output gaps. It is argued that output may be on an unsustainable path despite low and stable inflation if financial imbalances are accumulating. Borio et al (2013a) show that incorporating information on the financial cycle yields measures of potential output and output gaps for the US, UK and Spain that are estimated more precisely and are more robust in real time. With its well-developed financial markets and relatively open capital markets, the South African economy is potentially susceptible to the build-up of the sort of financial imbalances that characterised the recent financial crisis. However, existing measures of the output gap for South Africa do not generally incorporate information on the financial cycle. Using the framework developed in Borio et al (2013a), a finance-neutral measure of the output gap is estimated for South Africa. The traditional HP-filter is extended to incorporate information on credit and property prices. Including financial cycle proxies result in output gaps that are estimated more precisely and are more robust to data revisions and the arrival of new data points (i.e. estimated output gaps are more robust in real time), while also reflecting the impact of financial variables on economic activity. As such, the estimated finance-neutral output gap seems to represent a more appropriate measure on which to base monetary policy decisions than the traditional inflation-neutral measures prevalent in the literature.

Suggested Citation

  • 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.
  • Handle: RePEc:sza:wpaper:wpapers208
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    File URL: https://www.ekon.sun.ac.za/wpapers/2014/wp032014/wp-03-2014.pdf
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    References listed on IDEAS

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    Cited by:

    1. Christelle Grobler & Ben Smit, 2015. "Enhancing the financial sector linkages in the Bureau for Economic Research’s core macroeconometric model," Working Papers 21/2015, Stellenbosch University, Department of Economics.
    2. Johannes Kemp & Ben Smit, 2015. "Estimating and explaining changes in potential growth in South Africa," Working Papers 14/2015, Stellenbosch University, Department of Economics.
    3. repec:bla:sajeco:v:85:y:2017:i:2:p:161-177 is not listed on IDEAS

    More about this item

    Keywords

    Potential output; output gap; financial cycle; monetary policy;

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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