By Francesco Grigoli, Alexander Herman, Andrew Swiston, and Gabriel Di Bella
(Version in Español and Português)
In the wake of the global financial crisis, monetary and fiscal policies were used aggressively to counteract the effects of the crisis on economic activity. Policymakers look at a number of indicators to guide them in assessing an economy’s level of activity relative to its productive capacity. But trying to figure out the position of the economy in real time is often quite challenging, with consequences for setting policy.
In the case of Brazil in 2011, for example, policymakers estimated in real time that the economy was at a level of output consistent with its productive capacity. Over time, however, the assessment of the cyclical position of the Brazilian economy changed drastically. It had not just been at full capacity, but was overheating. The economy was actually facing inflationary pressures, requiring policy tightening to bring it back to the central bank’s target.
While striking, this experience is not unique to Brazil. In a recent study, we look at the implications for setting monetary policy in real time for a large set of countries, including five Latin American economies (Brazil, Chile, Colombia, Mexico, and Peru).
Output gap: important yet unpredictable
Imagine an economy operating at full productive capacity and a sustainable level of employment consistent with low and stable inflation. In other words, everything is in perfect balance, economically speaking. Economists refer to the amount an economy can produce in this state as potential output. Because it is not directly observable, potential output is difficult to measure. Nevertheless, it is useful to estimate it to serve as a benchmark against the actual state of the economy.
This difference between actual and potential output plays a crucial role in macroeconomics. If actual economic activity is below what the economy can produce at its capacity, stimulative policies (such as lowering interest rates) would normally be put in place to return the economy to potential. Conversely, more restrictive policies would be in order if actual activity is above potential output, to reduce overheating risks that could lead to a sudden, sharp downturn. Den Rest des Beitrags lesen »