Potential output from a euro-area perspective

This ECB working paper is worth going through. The potential output calculation is very important for policy makers, because deviations from the economy’s potential output tend to form a large part of the evaluation of macroeconomic performance used by the European Commission and others. Two recent Central Bank working papers discuss the impact on the Irish economy of these measure. See here and here. The estimates have been, shall we say, fairly far off the mark. The chart below shows this. Understanding the potential output calculation is therefore really important when we talk about policy responses to changes in fiscal policy, especially at the EU level.

 

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Author: Stephen Kinsella

Senior Lecturer in Economics at the University of Limerick.

27 thoughts on “Potential output from a euro-area perspective”

  1. The ECB has been hopeless at meeting its own inflation targets. The IMF admitted recently that its predictions for the EZ over the last 4 years were too rosy.

    I’m afraid forecasters are going to have to open the bonnet and have a good look at what is going on, distasteful and all as that is. Start with Draghi’s promises.

  2. Kostick et involucro have demonstrated in real time that official economic forecasting organisations basically always forecast either continuation of, or resumption of, prior LT trend. Your graph is another example of that.

  3. @ DoD

    I think Mario is a spoofer (say it in a Dublin accent)
    The ECB can’t do anything to stop deflation, not with the political standoff between debtor and creditor nations

    “The essence of dramatic tragedy is not unhappiness. It resides in the solemnity of the remorseless working of things”

    Alfred North Whitehead

  4. Seafoid,

    He could be the dealer in Blackjack. Jens is going to be forced to stick or twist. If it is stick, the European Project, European democracy and economy goes bang and Jens is going to have a rep in line with that of the Kaiser. Twist is massive easing of monetary conditions to prevent deflation. Over to you Dr No or should it be Blofeld.

  5. The most important driver of Irish economic growth and prosperity is staying on the technological frontier across a range of new industries. That is why this week’s Web Summit for example is very valuable to the economy. Those types of activities are the real drivers of the Irish economy and economists are just traffic wardens (or maybe popsicle ladies) keeping things flowing smoothly.

  6. It’s not just the ECB that doesn’t understand what is happening

    From the Torygraph in August

    “Just three months ago, Mark Carney, the Governor of the bank of England, still thought that wage growth would hit 2.5% by the end of the year. ; at yesterday’s inflation report he was forced to slash this to 1.25%”

    UK wages are going nowhere, just like US wages. Real UK wages have fallen by 10-12% since Lehman.

    Traders assume UK rates will revert to normal by 2017 but this is nonsense if consumers are not getting pay rises above inflation.

  7. @GC

    “The most important driver of Irish economic growth and prosperity is staying on the technological frontier across a range of new industries. That is why this week’s Web Summit for example is very valuable to the economy.”

    While it is undoubtedly true that staying on the technological frontier across a range of new industries is vital for economic growth, and the Web summit is a brilliant and successful event, economic growth depends just as much on more mundane activities. A large chunk (maybe most of it, I am not sure od the exact figures) of the benefit accruing to Ireland from this event comes in the form of revenues for hotel rooms. But, it is now clear that Dublin doesn’t have enough hotel rooms to cater for this event or for other events like the Garth Brooks concerts (before the Dublin City Kommissar stepped in and solved the problem by banning them). But, given the black mood back in 2011, if any entrepreneur, having anticipated the future rise in demand for hotel rooms in Dublin resulting from events such as these, and had then wanted a loan to build a 5-star 200m euros hotel in Dublin to cater for them, it is likely that the ‘committee for the prevention of unsafe lending’ would have prevented him getting the necessary loan (and indeed, having overdosed on Morgan Kelly, would probably have recommended the entrepreneur’s incarceration in a mental hospital).

    I see the media are whining that hotels in Dublin are putting up their prices for this event. While I don’t approve of this practice, in their defence they lost millions because of the last-minute cancellation of the Garth Brooks concerts in July, and are probably trying to recoup their losses. At least we should be grateful that Owen Keegan hasn’t banned the Web Summit, but I wouldn’t put it past him next year if the delegates make a lot of noise.

  8. @Seafoid

    Joseph Schumpeter — ‘History is a record of effects the vast majority of which nobody intended to produce.’

    Indeed! We might be seeing an example of this very soon.

    The implications for the UK of the UK leaving the EU will be that there is no more UK. Halleluia. Any decision by the UK to leave the EU will certainly trigger another referendum in Scotland, which this time ‘yes’ will win, as Scotland is clearly in favour of remaining in the EU and will not be forced out just because Little England says so. Since the September referendum, SNP membership has soared to almost 100k, they are at 52 per cent in the polls, and the traitor Labour Party is in meltdown. To my shame, they look like electing an Irish Catholic Celtic supporter as their new leader to try and save the Union, the Sir Edward Carson of Scotland. When the referendum comes, I will certainly vote in favour of the UK leaving in order to advance this scenario.

  9. JTO,

    Scotland is fascinating. It looks like the SNP will take 30 seats off the lab & libs in the next Westminster election and end up holding the balance of power with the other nats…SDLP, PC & DUP (really just unionst nats). It reminds one of the 19th century when Parnell held the balance of power and almost got HR. Would SF then be persuaded to take seats in a hung parliament.
    We could then end up with a bizarre situation in 2016-SF Taoiseach, SF first minister and SF holding some influence in Westminster.

  10. The latest European Commission economic forecasts
    (http://ec.europa.eu/economy_finance/)show potential output in the euro area at just 0.6% over the next few years, which if true implies a pretty bleak outlook.
    The problem is though that potential output calculations tend to be cyclical i.e. they become pessimistic after a downturn and optimistic in an upturn. Take Ireland. In the Spring the EC assumed that Irish potential growth this year was 1.3% and that actual growth would be 1.7%. The latter is now projected at 4.6%, with potential output revised up to 2.2%. Similarly next year’s potential is now put at 2.8% from an initial 2.0%.
    Potential output calculations are always fragile and to use them as a pillar to support strictures on fiscal policy adjustment is not sensible. Indeed, in the Irish case the scale of migrant flows makes it impossible to calculate potential output.

  11. The issue is not so much a question of the UK leaving the EU but a twofold one of (i) where would it go and (ii) what would be the implications for Ireland?

    As there is no obvious answer to (i), this makes it highly unlikely that the UK will, in fact, leave and question (ii) will not have to be answered.

    Cameron is misreading the mood in the other countries, and especially Germany, to such an extent that he is becoming the target of ridicule in no less a paper than the FT.

    http://www.ft.com/intl/cms/s/0/89088d16-5e9f-11e4-b81d-00144feabdc0.html?siteedition=intl#axzz3I1Xn3YEy

  12. @ Gregory Connor

    The Web Summit is a phenomenal success and is an illustration of how combining with the culture and drink/food resources can be used to good effect.

    The challenge for policy is that FDI firms tend to locate research in Israel and administration in Ireland.

    Paddy Cosgrave, co-founder of the Web Summit. commented in a tweet on the article below:

    “Phenomenal level of research + info in this post about Irish tech policy & startups in general”

    Dublin Web Summit 2014: Separating hype and reality

    @ All

    In 2013 the Balance of Payments surplus would have become a deficit if tax inversions (companies that move their tax residency to Ireland for tax purposes) were excluded.

    The other factor in output is that while net exports are no impacted in a significant way, €45bn of tax related exports artificially boosts the output total.

  13. @Dan

    I think you can often substitute official projections of potential output with a simple moving average function applied to the historic data. If you plot it and play about with the length of the moving average you can illustrate the effect of the lags into and out of turning points.

    To model projections of potential output you stick in a longer moving average.

    I think Gavin’s envelope could do it easily.

  14. Irl IMF repayment issue about 2.5% on 15yr today. 102 over mid swaps. Over 8bn demand.

    CBI holding sales would not appear to be very relevant to financial stability.

  15. Right. I give up…

    To model projections of potential output you stick in a shorter moving average.

  16. http://www.theguardian.com/world/2014/nov/04/european-commission-cuts-eurozone-growth-forecasts

    “The European commission has slashed its forecasts for eurozone growth this year and next and warned there would be no magic bullet to turn around its fortunes. The EC cut its forecast for growth in 2014 to 0.8% from a previous forecast of 1.2%. It expects growth in 2015 to be 1.1%, and not 1.7% as it stated previously.”

    But never mind. The BoJ has unleashed another round of QE so there’ll be a melt up in the S&P and then Euro equities will look attractive and it won’t crash before Christmas and 2015 is such a long way away

  17. “The ECB, Fed and BoJ have pumped 9.5 trillion dollars into financial markets and boosted asset prices to record levels but there is no exit velocity growth anywhere.”

    I suppose that’s what happens when you deliberately fill up the fuel tank of a diesel powered vehicle with lead-free petrol. Fine as long as you keep the engine running. Bit chuggy. Just do not expect it to re-start after you stop it. Then you have to call some assistance to clear out the fuel tank and lines. Then you have to get some of the correct fuel. Good luck EZ!

  18. ~Ten Trillion! Wow! The Derivatives Death Star must be a hungry beast.

    I usually ask Patricia Heisenberg from Ballybrack, me best dub axint and calculator of hard sums, to help me out on these … but she is out on the razz with the Pats supporters – allegedly hoping to get a scoring pass from some fahy fella …. must pass this one on to her next week.

    Wonder what would have happened if the Ten Trillion were passed on to citizens?

  19. @seafoid

    The Neu Washington Consensus – it all flows up,up, up, an away.

    Spose we will have to call it Trickle-Up Ekonomicks.

    As for the ‘price of a pint’:

    ‘The public revolt against water charges is not, for the most part, a rebellion against the eminently sensible idea that a small State should have a single public utility to develop its water system. It’s an expression of anger about bigger things: command-and-control politics; trust-me- I’m-an-expert arrogance; rotten, feckless disregard for the realities of life at the bottom of the heap; the feeling that nobody gives a curse how you live or what you think.

    It’s about injustice, and it’s justified. The recent budget was the fourth regressive budget in a row.’

    http://www.irishtimes.com/news/politics/the-irish-water-debacle-why-the-state-is-heading-towards-being-ungovernable-1.1986550

    This German Ideology will destroy the EU … a putsch anyone?

  20. Oh FFS!

    Their potential output estimates would be influenced by a longer moving av (of historic data) than their actual output forecasts.

    I’m not coming back to this thread.

    @Seafoid

    Its an available option and powerful groups are unlikely to complain because it assists them. How would they refuse to give it a go?

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