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Unemployment or Credit: Who Holds The Potential? Results From a Small-Open Economy

Mihnea Constantinescu and Anh Nguyen

No 4, Bank of Lithuania Discussion Paper Series from Bank of Lithuania

Abstract: This paper investigates the importance of unemployment and credit in determining the potential level of real activity for a small-open economy with a low degree of financialization. We estimate a multivariate unobserved component model (MUC) to derive the potential output and its 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. We find that the inclusion of unemployment into the MUC model substantially improves the estimates of output gap in real-time. Once information about unemployment is accounted for, adding information about credit does not substantially alter either the estimates of output gap or its performance in real time. We uncover a strong negative correlation between the model-implied unemployment gap (without credit) and real credit growth. This explains the relatively muted impact of the financial variable on the level and dynamics of the output gap. Data revisions appear not to be the primary source of revisions on output gaps 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)
Pages: 28 pages
Date: 2017-04-24
New Economics Papers: this item is included in nep-eec and nep-mac
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