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Finance, Potential Output and the Business Cycle: Empirical Evidence from Selected Advanced and CESEE Economies

Author

Listed:
  • Dominik Bernhofer
  • Octavio Fernández-Amador
  • Martin Gächter

    (Oesterreichische Nationalbank, Foreign Research Division)

  • Friedrich Sindermann
Abstract
Traditional approaches to separate the underlying trend of potential output from cyclical developments mostly rely on the concept of nonaccelerating inflation output and are thus unable to detect upswings caused by the financial cycle, which often appear to be unsustainable in the long run. In this study, we therefore propose to extend the structural unobserved components model developed by Harvey (1989) and Harvey and Jaeger (1993) by including information on the financial cycle, i.e. private credit and house price developments, to explain the cyclical deviations from potential GDP. Thus, we are able to calculate “finance-neutral” potential output and corresponding “finance-augmented” output gaps, which take the effect of financial variables into account. We apply this novel concept to four advanced economies (AT, IE, NL, US) and four economies in Central, Eastern and Southeastern Europe (BG, EE, PL, SK) in a comparative manner. Our results show a considerable impact of the financial cycle on business cycle developments in most of the economies under review, both advanced and emerging. Remarkably, our finance-augmented output gaps exhibit a considerably higher explanatory power for the variation of observed unemployment rates in corresponding economies than standard approaches (such as the HP filter). In other words, our results considerably strengthen the case for considering the financial sector in business cycle measurement.

Suggested Citation

  • Dominik Bernhofer & Octavio Fernández-Amador & Martin Gächter & Friedrich Sindermann, 2014. "Finance, Potential Output and the Business Cycle: Empirical Evidence from Selected Advanced and CESEE Economies," Focus on European Economic Integration, Oesterreichische Nationalbank (Austrian Central Bank), issue 2, pages 52-75.
    • Handle: RePEc:onb:oenbfi:y:2014:i:2:b:1
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Grintzalis, Ioannis & Lodge, David & Manu, Ana-Simona, 2017. "The implications of global and domestic credit cycles for emerging market economies: measures of finance-adjusted output gaps," Working Paper Series 2034, European Central Bank.
    2. Octavio Fernández-Amador & Martin Gächter & Friedrich Sindermann, 2016. "Finance-augmented business cycles: A robustness check," Economics Bulletin, AccessEcon, vol. 36(1), pages 132-144.
    3. Gábor P. Kiss, 2020. "Aggregate Fiscal Stabilisation Policy: Panacea or Scapegoat?," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 19(2), pages 55-87.
    4. Amat Adarov, 2017. "Financial Cycles in Credit, Housing and Capital Markets: Evidence from Systemic Economies," wiiw Working Papers 140, The Vienna Institute for International Economic Studies, wiiw.
    5. Kátay Gábor & Kerdelhué Lisa & Lequien Matthieu, 2020. "Semi-Structural VAR and Unobserved Components Models to Estimate Finance-Neutral Output Gap," Working papers 791, Banque de France.
    6. Fernández-Amador, Octavio, 2016. "Finance-augmented business cycles: A robustness check," Papers 1038, World Trade Institute.

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    More about this item

    Keywords

    financial cycle; potential output; business cycles; output gap; emerging markets; finance-neutral potential output; finance-augmented output gaps;
    All these keywords.

    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G01 - Financial Economics - - General - - - Financial Crises

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