of the global financial crisis— although they were estimated to be small or even negative at the time. This revised view of history is purely a statistical artifact of creating smooth trends through structural breaks, such as permanent output declines, in the GDP data.
“We still don’t understand very well why transitory shocks from the financial sector or elsewhere can lead to a persistent fall in productivity, employment, and investment.”
Policymakers can face large pitfalls using these conventional outputgapconcepts and estimates. For example
calculation of structural deficits is to correct for the cyclical position of the economy; this is routinely done for industrial countries using an “outputgap” concept. We therefore first establish the correlation, country by country, between the fiscal balance and the GDP growth rate (or, corresponding to an output gap, the cumulative growth rate, net of the average for the period 1995-2001).
This leads to a distinction between those countries for which the correlation is strong and positive (Benin, Mali) and those for which, on the contrary, it is decidedly negative
that uses the outputgapconcept consistent with a theoretical definition of the ‘natural rate of output’ in the absence of nominal wage and price rigidities and with no ‘mark-up’ shocks to wages and prices.
The output gap in the model is defined as a deviation of the ‘natural rate of output’ from the actual output. Despite a very different definition and modeling framework from most empirical measures of the output gap, all tools discussed in the paper continue to apply. The decomposition of the flexible-price output gap is depicted in Fig. 7
Figure 7. Output
We argue that in an economy with downward nominal wage rigidity, the output gap is negative on average. Because it is more difficult to cut wages than to increase them, firms reduce employment more during downturns than they increase employment during expansions. This is demonstrated in a simple New Keynesian model with asymmetric wage adjustment costs. Using the model's output gap as a benchmark, we further show that common output gap estimation methods exhibit a systematic bias because they assume a zero mean. The bias is especially large in deep recessions when potential output tends to be most severely underestimated.
Jelle Barkema, Tryggvi Gudmundsson, and Mr. Mico Mrkaic
Estimates of output gaps continue to play a key role in assessments of the stance of business cycles. This paper uses three approaches to examine the historical record of output gap measurements and their use in surveillance within the IMF. Firstly, the historical record of global output gap estimates shows a firm negative skew, in line with previous regional studies, as well as frequent historical revisions to output gap estimates. Secondly, when looking at the co-movement of output gap estimates and realized measures of slack, a positive, but limited, association is found between the two. Thirdly, text analysis techniques are deployed to assess how estimates of output gaps are used in Fund surveillance. The results reveal no strong bearing of output gap estimates on the coverage of the concept or direction of policy advice. The results suggest the need for continued caution in relying on output gaps for real-time policymaking and policy assessment.
Jelle Barkema, Tryggvi Gudmundsson, and Mr. Mico Mrkaic
. Section VI concludes.
II. Related Literature and Recent Debate
The pre-Covid-19 assessment of output levels being generally close to or above potential in most advanced economies invigorated the debate about the outputgapconcept with disagreements on the amount of slack and the consequences for policy (see e.g. IIF(X)). However, such discussions are certainly not new and there is a rich tradition on the topic in the literature going back decades 3 . Okun (1962) provided an argument for the use of potential output, covering general aspects such as measurement
This paper discusses several popular methods to estimate the ‘output gap’. It provides a unified, natural concept for the analysis, and demonstrates how to decompose the output gap into contributions of observed data on output, inflation, unemployment, and other variables. A simple bar-chart of contributing factors, in the case of multi-variable methods, sharpens the intuition behind the estimates and ultimately shows ‘what is in your output gap.’ The paper demonstrates how to interpret effects of data revisions and new data releases for output gap estimates (news effects) and how to obtain more insight into real-time properties of estimators.
IMF Research Perspective (formerly published as IMF Research Bulletin) is a new, redesigned online newsletter covering updates on IMF research. In the inaugural issue of the newsletter, Hites Ahir interviews Valeria Cerra; and they discuss the economic environment 10 years after the global financial crisis. Research Summaries cover the rise of populism; economic reform; labor and technology; big data; and the relationship between happiness and productivity. Sweta C. Saxena was the guest editor for this inaugural issue.
This paper reviews the experience of fiscal adjustment undertaken in the West African Economic and Monetary Union (WAEMU) countries since the entry into force of the 1994 treaty establishing the framework for a regional convergence of national fiscal policies. We propose a measure of the structural deficit that corrects for movements of both the business cycle and terms of trade. Though the fiscal deficit worsened in 1998-2001 in some countries because of terms of trade deterioration and unfavorable movements in the business cycle, convergence stalled even when corrected for these factors. Meeting fiscal deficit targets in the future will be facilitated by a favorable external environment but, in any case, will require a higher revenue ratio and downward pressure on government wages as shares of GDP.
analyzed more thoroughly by attempting to link these slippages to economic or political causes. Were there factors external to the region that could explain the poor fiscal performance? Were there political factors in some countries that may have influenced developments related to the criteria?
A standard approach to the calculation of structural deficits is to correct for the cyclical position of the economy; this is routinely done for industrial countries using an “outputgap” concept. We, therefore, first establish the correlation, country by country, between the