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Possible impacts of the financial crisis on potential output

Péter Gábriel and Gergõ Motyovszky
Authors registered in the RePEc Author Service: Gergő Motyovszki

MNB Bulletin (discontinued), 2013, vol. 8, issue 2, 21-30

Abstract: In a normal economic cycle, monetary policy decisions are not influenced directly by the size of potential output. In making their decisions, central banks take into account the difference between potential and actual output, i.e. the size of the output gap, which shows the cyclical position of the economy and is one of the main determinants of inflationary pressure. The underlying observation is that monetary policy is unable to influence the trend of potential growth, and it is rather only able to smooth cyclical fluctuations in aggregate demand. At the same time, in the case of a major and persistent economic downturn, when it is possible that permanently falling demand reduces the supply potential as well, by influencing demand and the length of the crisis, a more expansive monetary policy may have an indirect impact on the supply side as well, and may mitigate the damage to potential output. In order to maintain price stability and support recovery from the crisis, it is of key importance for monetary policy to know the size of the output gap and the expected path of potential output. Following the outbreak of the crisis, the output of most economies declined considerably. The recovery is slow and fragile, and the trend of expansion to be followed by economies after the crisis subsides is uncertain. This study describes the channels through which the financial crisis may have affected potential output and outlines some possible scenarios in connection with longer-term developments in potential output.

Keywords: potential output; business cycle; monetary policy. (search for similar items in EconPapers)
JEL-codes: E32 E58 (search for similar items in EconPapers)
Date: 2013
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