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We study the properties of the IMF-WEO estimates of real-time output gaps for countries in the euro area as well as the determinants of their revisions over 1994-2017. The analysis shows that staff typically saw economies as operating below their potential. In real time, output gaps tend to have large and negative averages that are largely revised away in later vintages. Most of the mis-measurement in real time can be explained by the difficulty in predicting recessions and by overestimation of the economy’s potential capacity. We also find, in line with earlier literature, that real-time output gaps are not useful for predicting inflation. In addition, countries where slack (and potential growth) is overestimated to a larger extent primary fiscal balances tend to be lower and public debt ratios are higher and increase faster than projected. Previous research suggests that national authorities’ real-time output gaps suffer from a similar bias. To the extent these estimates play a role in calibrating fiscal policy, over-optimism about long-term growth could contribute to excessive deficits and debt buildup.
We study the properties of the IMF-WEO estimates of real-time output gaps for countries in the euro area as well as the determinants of their revisions over 1994-2017. The analysis shows that staff typically saw economies as operating below their potential. In real time, output gaps tend to have large and negative averages that are largely revised away in later vintages. Most of the mis-measurement in real time can be explained by the difficulty in predicting recessions and by overestimation of the economy’s potential capacity. We also find, in line with earlier literature, that real-time output gaps are not useful for predicting inflation. In addition, countries where slack (and potential growth) is overestimated to a larger extent primary fiscal balances tend to be lower and public debt ratios are higher and increase faster than projected. Previous research suggests that national authorities’ real-time output gaps suffer from a similar bias. To the extent these estimates play a role in calibrating fiscal policy, over-optimism about long-term growth could contribute to excessive deficits and debt buildup.
We apply a range of models to the U.K. data to obtain estimates of the output gap. A structural VAR with an appropriate identification strategy provides improved estimates of output gap with better real time properties and lower sensitivity to temporary shocks than the usual filtering techniques. It also produces smaller out-of-sample forecast errors for inflation. At the same time, however, our results suggest caution in basing policy decisions on output gap estimates.
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.
A push-pull-brake model of capital flows is used to study the effects of fiscal policy changes on private capital flows to emerging Europe during 2000-07. In the model, countercyclical fiscal policy has two opposing effects on capital inflows: (i) a conventional absorptionreducing effect, as a tighter fiscal stance acts as a brake on capital flows; and (ii) an unconventional absorption-boosting effect, as a tighter fiscal stance increases investor confidence in the country. The empirical results suggest that push factors (low returns in flow-originating countries), rather than pull factors (high returns in flow-destination countries), drove most of the private capital flows to emerging Europe. And active countercyclical fiscal policy once the fiscal stance is adjusted for the automatic effects on the fiscal position of both internal and external imbalances acted as a brake on capital inflows. However, the empirical results also suggest that, even abstracting from political feasibility and fiscal policy lag considerations, countercyclical fiscal policy alone is unlikely to be an effective policy tool to put an effective brake on sudden capital flow surges.
This book explains why inflation remains subdued after recessions, based on three revolutionary concepts: defensive expectations, compensatory savings, and cumulative wage gap. When income falls, consumption falls, and savings rise, as people rebuild their past wealth. Households will not spend more until they fully recover what they lost. The revised Phillips Curve explains that current inflation depends on the cumulative difference between current income and past income. This new theory is tested and validated by data for US since 1960 to date and for 35 OECD countries from 1990 to date. A number of policy implications are derived from these results. The book calls for an optimal policy mix between monetary policy and fiscal policy; it also discusses the coronavirus crisis as an extreme case of defensive expectations.
Public debt ratios in Europe increased significantly in response to the pandemic and energy shocks and have remained higher than before the pandemic in most countries. Going forward, the projected public debt trajectories are broadly flat overall in advanced Europe but have a rising profile in emerging Europe. Government financing needs are still elevated, and the unwinding of quantitative easing by major central banks adds to financing pressures. Moreover, there are important medium- to long-term spending pressures from defense, climate transition, and aging, which are not fully reflected in the projected baseline trajectories. Against this backdrop, the risk that debts will not stabilize in the medium term has increased. Debt stabilization will hinge critically on achieving ambitious fiscal consolidation and sustained growth. Facing these elevated risks, policymakers need to implement carefully-calibrated fiscal adjustments that ensure debt sustainability while supporting growth. They could target debt stabilization over a longer, 10-year, horizon—while adhering to credible fiscal rules such as the reformed EU Economic Governance Framework—but with a high probability to reassure markets that debts will indeed be tamed.
This paper outlines a simple three-country macroeconomic model designed to focus on the transmission of external shocks to Portugal. Building on the framework developed by Berg et al (2006), this model differentiates between shocks originating from both inside and outside the euro area, as well as domestic shocks, each of which have different implications for Portugal. This framework is also used to consider the dynamics of the Portuguese economy over recent decades. The model, which is designed to guide forecasts and undertake simulations, can easily be modified for use in other small euro area countries.
Broadening and deepening of economic and political integration are hallmarks of the EU and ASEAN. Analysing the economic and institutional changes in both Europe and Asia, this book emphasizes on banking, financial market dynamics, ICT, and macroeconomic policies. The legal aspects are combined with historical and economic perspectives
A careful review has revealed significant scope to modernize and better align the MAC DSA with its objectives and the IMF’s lending framework. This note proposes replacing the current framework with a new methodology based on risk assessments at three different horizons. Extensive testing has shown that the proposed framework has much better predictive accuracy than the current one. In addition to predicting sovereign stress, the framework can be used to derive statements about debt stabilization under current policies and about debt sustainability.