Potential output in times of temporary supply shocks

Guzmán González-Torres Fernández, José Emilio Gumiel and Béla Szörfi

Economic Bulletin Boxes, 2024, vol. 8

Abstract: According to the estimates of major international institutions, the euro area output gap remained negative or very close to zero in the aftermath of the pandemic and at the onset of the war in Ukraine, despite the rise in euro area core inflation. This contrasts with most available historical data, which show a positive association of a rise in inflation above its medium-run average with an increase in the output gap. This may reflect the fact that demand shocks have historically had a larger effect on the business cycle relative to supply shocks. However, the shocks that hit the euro area after 2020 – disruptions in supply chains and significant increases in input prices – predominantly came from the supply side of the economy. This box explores how accounting for the role of temporary supply shocks in determining potential output can restore the positive association of the output gap with high inflation after 2020. First, the box discusses the concept of potential output as used by most international organisations. It then looks at indicators that could capture recent exceptional demand and supply conditions. Lastly, using information on these indicators, the box proposes complementary slack measures that better reflect inflationary pressures in times of temporary supply shocks. JEL Classification: E31, E32, E37, E58

Keywords: output gap; Potential output; slack; supply shocks (search for similar items in EconPapers)
Date: 2024-01
Note: 2322646
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