Unemployment or credit: Which one holds the potential? Results for a small open economy with a low degree of financialization

Mihnea Constantinescu and Anh Nguyen

Economic Systems, 2018, vol. 42, issue 4, 649-664

Abstract: This paper investigates the relative importance of unemployment versus credit in determining the potential level of real activity for a small open economy with a low degree of financialization. We use a multivariate unobserved component model (MUC) to derive the potential output and the associated output gap for the Lithuanian economy. The model is estimated via Bayesian methods and the time paths of unobserved variables are extracted via the Kalman filter. The inclusion of unemployment in the MUC model substantially improves the estimates of the output gap in real time. Adding information about credit further emphasizes the overheating of the economy in the pre-crisis period, both in real time and ex post. Including credit preserves the conclusions regarding turning points. We uncover a strong negative correlation between the model-implied unemployment gap (without accounting for credit) and real credit growth. Data revisions do not appear to be the primary source of revisions of output gap estimates.

Keywords: Potential output; Output gap; Multivariate unobserved component; Kalman filter; NAIRU; Real financial cycle; Small open economy (search for similar items in EconPapers)
JEL-codes: C11 C32 E24 E32 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecosys:v:42:y:2018:i:4:p:649-664

DOI: 10.1016/j.ecosys.2018.08.003

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