Mind the Gap: Computing Finance-Neutral Output Gaps in Latin-American Economies

Amador-Torres, Juan and Gómez González, Jose and Ojeda-Joya, Jair and Jaulin-Mendez, Oscar and Tenjo-Galarza, Fernando (2015): Mind the Gap: Computing Finance-Neutral Output Gaps in Latin-American Economies.

Abstract

We compute a measure of the finance-neutral potential output for Colombia, Chile and Mexico. Our methodology is based on Borio et al (2013, 2014) and incorporates the cycle of credit, house prices and the real exchange rate on the computation of the output gap. The literature on business cycles in emerging market economies, particularly papers focusing on Latin American economies, has highlighted the importance of including shocks to the interest rate in world capital markets together with financial frictions; terms of trade fluctuations; and a procyclical government spending process. Our results show that around the financial crises of the 1990s the finance-neutral output gap behaved differently than the traditional measures observed by policymakers. In particular, gaps are higher before crises and lower after them.

• Item Type: MPRA Paper
• Language: English
• Keywords: Potential output, financial cycle, asset prices, Kalman filter
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E47 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Adrian, T., P. Colla and H.S. Shin (2012): “Which Financial Frictions? Parsing the Evidence from the Financial Crisis of 2007-9”, NBER Macro Annual Conference, April 20-21, 2012.

Aikman, D., Haldane, A., and Nelson, B. (2011), “Curbing the Credit Cycle”, Bank of England, Speech 463.

Alessi, L. and Detken, C., (2011), “Quasi real time early warning indicators for costly asset price boom/bust cycles: A role for global liquidity”, European Journal of Political Economy, vol. 27(3), pp. 520-533.

Apel, M. and P. Janson (1999): “A Theory-Consistent System Approach for Estimating Potential Output and the NAIRU”, Economics Letters, Vol. 64, No. 3, 271 – 275.

Basu, S. and J. Fernald, (2009): “What Do We Know (And Not Know) About Potential Output?” Review, Federal Reserve Bank of St. Louis, issue Jul, pages 187-214.

Billmeier, A. (2004): “Ghostbusting: Which Output Gap Measure Really Matters?”, IMF Working Paper No. 04/146.

Borio, C. (2012): “The Financial Cycle and Macroeconomics: What Have We Learnt?”, BIS working paper No 395, Bank for International Settlements.

Borio, C. and Drehmann, M., (2009): “Assessing the risk of banking crises - revisited”, BIS Quarterly Review, March.

Borio, C., P. Disyatat, and M. Juselius (2013): “Rethinking Potential Output: Embedding Information about the Financial Cycle,” BIS Working Papers #404.

Borio, C., P. Disyatat, and M. Juselius (2014): “A Parsimonious Approach to Incorporating Economic Information in Measures of Potential Output,” BIS Working Papers #442.

Bracke, T., M. Bussiere, M. Fidora, and R. Straub, (2008): “A Framework for Assessing Global Imbalances,” Occasional Paper Series # 78, European Central Bank

Cobo A. (2005). "Output Gap In Colombia: An Eclectic Approach," Borradores de Economia 327, Banco de la Republica.

Claessens, S., Kose, M. and Terrones, M., (2012): “How do Business and Financial Cycles Interact?”, Journal of International Economics, 87(1): 178-190.

Doménech, R. and V. Gómez (2006): “Estimating Potential Output, Core Inflation, and the NAIRU as Latent Variables”, Journal of Business and Economic Statistics, Vol. 24, No. 3, 354 – 365.

Drehmann, M., Borio, C. and Tsatsaronis, K., (2012): "Characterising the Financial Cycle: Don't Lose Sight of the Medium Term!” BIS Working Papers 380, Bank for International Settlements.

Friedman, M. (1968): “The Role of Monetary Policy,” American Economic Review, 58(1): 1-17.

Goodhart, C. and Hofmann, B., 2008, “House prices, money, credit and the macroeconomy”, Oxford Review of Economic Policy, 24: 180-205.

Gomez-Gonzalez, J., J. Ojeda-Joya, C. Rey, and N. Sicard. (2015). “Testing for Bubbles in the Colombian Housing Market: A New Approach,” Desarrollo y Sociedad, 75: 111-136, June.

Gómez-González, J., J. Ojeda-Joya, F. Tenjo and H. Zarate. (2014). “Testing for Causality between Credit and Real Business Cycles in the Frequency Domain: An Illustration”, Applied Economics Letters, 21(10): 697-701.

Kiyotaki, N. and J. Moore (1997): “Credit Cycles,” Journal of Political Economy, Vol. !05, No 2, 211-248.

Kuttner, K.N. (1996): “Estimating Potential Output as a Latent Variable”, Journal of Business & Economic Statistics, Vol. 12, No. 3, 361 - 368.

Minetti, R. and T. Peng, (2013). "Lending Constraints, Real Estate Prices and Business Cycles in Emerging Economies," Journal of Economic Dynamics and Control, 37(12), pp. 2397-2416.

Mishkin, F. (2007): “Estimating Potential Output,” Speech delivered at the Conference on Price Measurement for Monetary Policy, Federal Reserve Bank of Dallas.

Neiss, K. and E. Nelson, (2002): “Inflation Dynamics, Marginal Cost, and the Output Gap: Evidence from Three Countries”. Proceedings, Federal Reserve Bank of San Francisco.

Ng, E., (2011): “Forecasting US Recessions with Various Risk Factors and Dynamic Probit Models”, Journal of Macroeconomics, 34(1): 112–125.

Okun, A. (1962): “Potential GNP, its Measurement and Significance,” Cowles Foundation, Yale University

Oviedo, M. (2004): "Macroeconomic Risk and Banking Crises in Emerging Market Countries: Business Fluctuations with Financial Crashes," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.

Phelps, E. (1967): “Phillips Curves, Expectations of Inflation and Optimal Unemployment over Time,” Economica, 34: 254-281.

Samuelson, P., and R. Solow, (1960): “The Problem of Achieving and Maintaining a Stable Price Level: Analytical Aspects of Anti-inflation Policy,” American Economic Review, Papers and Proceedings, 50(2): 177-194.

Schularick, M. and Taylor, A.M., (2012): “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles, and Financial Crises, 1870-2008”, American Economic Review, 102 (2): 1029-61.

Smets, F. (2002): “Output Gap Uncertainty: Does it Matter for the Taylor Rule?”, Empirical Economics, Vol. 27, No. 1, 113 – 129.

Tenjo, F. and López, M., (2010): “Early Warning Indicators for Latin America”, Ensayos Sobre Política Económica, Banco de la República, vol. 28(63), pp. 232-259.

Vetlov, I., T. Hlédik, M. Jonsson, H. Kucsera, and M. Pisani, (2011): "Potential Output in DSGE Models," Working Paper Series 1351, European Central Bank.