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Potential Output and Fiscal
Challenges
Philip Bagnoli, OECD
FRB Workshop: L’impact de la crise sur la croissance de
l’économie et les finances publiques : les réflexions et
évaluations des économistes
27 October 2009
Outline
OECD estimate of the impact on potential
–
production function and filter based
–
Includes capital and potential labour (with labour efficiency)
Areas where some impact is historically evident
–
Capital
–
NAIRU
Areas where impact is historically nuanced
–
Participation rates
Areas where impact it is ambiguous
–
Total factor productivity
Fiscal challenges
OECD change in potential growth
Estimated effects on potential
OECD potential growth rate
(% pa)
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
2011
2012 2013 2014 2015
“Level” effect from reduced capital intensity and labour input, see
Chapter 4 of OECD Economic Outlook No 85. Growth effect not
distinguishable.
Estimated effects on potential
… broadly consistent with evidence from
previous severe downturns
Potential output growth (% pa), 5 yrs following start of
downturn compared to 5 yrs preceding it
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
FIN NOR ITA NLD CAN SWE BEL ESP ITA JPN CAN AUS DNK AUT USA FRA USA UK IRL
91 88 92 81 80 91 81 93 82 98 91 91 88 91 91 81 81 80 92
OECD change in potential through capital
2008-2011
Weighted average
Unweighted average
0.00%
-0.50%
-1.00%
Average % per annum
Estimated effects via capital
Non-housing investment growth
-1.50%
-2.00%
-2.50%
-3.00%
-3.50%
-4.00%
-4.50%
-5.00%
“Level” effect from reduced capital intensity, see Chapter 4 of
OECD Economic Outlook No 85.
Growth in the capital stock falls, particularly
following banking crises
Estimated effects via capital
Capital stock growth (% pa), 5 yrs following start of
downturn compared to 5 yrs preceding it
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
-2.5
-3.0
-3.5
-4.0
FIN ESP NOR CAN SWE AUT ITA ESP ITA FRA UK JPN NLD AUS USA DNK BEL CAN USA IRL
91 79 88 91 91 91 92 93 82 81 80 98 81 91 91 88 81 80 81 92
For current projections, long-run decline in capital intensity is based on a
static equilibrium calculation of the effect of higher capital costs, reflecting
permanently higher risk aversion (see Box 4.2 in EO85). Much of this
adjustment is projected to have already taken place by end 2010.
Estimated effects via NAIRU
Hysteresis effects on the NAIRU vary
considerably across countries
Increase in NAIRU varies according to:
 proportion of rise in unemployment that is translated into long-term
unemployment
 relative effect of long-term unemployed on inflation
 Extent of recent institutional reforms (esp to EPL, unemployment benefits)
12
10
8
6
4
2
0
IRL ESP ITA TUR HUN CZE ISL BEL AUT NLD PRT GRC GBR FRA FIN DNK DEU AUS NOR LUX CAN NZL USA CHE SWE JPN MEX KOR
-2
Change in NAIRU 2007-2010
Change in actual unemployment 2007-2010
OECD change in potential through labour
Potential employment
% chng in potential employment at peak
Estimated effects via NAIRU
Unweighted average
Weighted average
0.00%
-0.20%
-0.40%
-0.60%
-0.80%
-1.00%
-1.20%
-1.40%
-1.60%
“Level” effect mainly from increased NAIRU, see Chapter 4 of OECD
Economic Outlook No 85.
+0.02 pp annual weighted average improvement in NAIRU for 20122017.
Likely effects via participation
Trend labour force participation is typically
reduced following severe downturns
Trend labour force participation rate (%), average
annual change 5 yrs following start of downturn compared to 5 yrs
preceding it
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
NOR CAN SWE FIN AUT FRA CAN AUS DNK JPN BEL USA USA ITA
88 91 91 91 91 81 80 91 88 98 81 81 91 82
ITA
92
UK NLD ESP
80 81 93
IRL
92
Severe recessions have long-lasting effects on participation. Young
often most affected (more education?). But also country-specific
evidence of hysteresis–type effects.
TFP effects are mixed, but more likely to be
negative when regulation is anti-competitive
Correlation coefficient = -0.35
(t-ratio = -1.6 )
0.8
IRL 92
Excluding Ireland
Correlation coefficient = -0.44
(t-ratio = -2.0)
0.6
Change in TFP growth (% pa)
Tentative thoughts on tfp
1.0
AUS 91
0.4
CAN 91
SWE 91
0.2
FIN 91
0.0
-0.2
USA 91
2.0
USA 80
3.0
FRA 81
UK 80
4.0
5.0
ESP 79
AUT 91
JPN 98
DNK 88 6.0
ITA 92
CAN 80
-0.4
-0.6
ESP 93
BEL 81
NLD 81
-0.8
-1.0
ITA 82
NOR 88
Index of anti-competitive product market regulation
… but there is wide variation across countries
OECD estimates of hit to potential
(unweighted average is 4%)
JPN USA NZL CAN AUT AUS DNK PRT FRA FIN GBR SWE GRC BEL NLD DEU ITA POL ESP IRL
0.0
-2.0
-4.0
-6.0
Lower Potential employment
Higher capital costs
-8.0
-10.0
-12.0
Debts, deficits and stylised consolidation
Fiscal challenge
EO85 Fiscal trends in the stylised medium-term scenario
As a percentage of nominal GDP
Financial
balances
2007
No consolidation
Denmark
Finland
Hungary
Korea
Norway
Sweden
Switzerland
4.5
5.2
-4.9
4.7
17.7
3.8
1.3
2010
-4.1
-2.8
-4.2
-2.3
7.0
-4.5
-2.5
Net financial
liabilities
2017
0.8
3.1
0.8
1.1
8.6
1.5
-0.3
2007
-4
-71
53
-36
-143
-20
12
2010
2
-47
61
-31
-138
-6
14
Gross financial
liabilities
2017
3
-44
45
-21
-142
-8
18
2007
32
41
72
26
58
48
48
2010
51
52
87
39
72
57
48
2017
53
55
61
49
66
56
52
Debts, deficits and stylised consolidation
EO85 Fiscal trends in the stylised medium-term scenario
As a percentage of nominal GDP
Financial
balances
Fiscal challenge
2007
Three years of
consolidation
Australia
Austria
Belgium
Canada
Czech Republic
France
Germany
Greece
Iceland
Italy
Japan
Luxembourg
Netherlands
New Zealand
Poland
Portugal
Slovak Republic
1.8
-0.7
-0.3
1.6
-0.6
-2.7
-0.2
-3.9
5.4
-1.5
-2.5
3.6
0.3
5.0
-1.9
-2.7
-1.9
2010
-5.0
-6.1
-6.1
-5.9
-4.9
-7.9
-6.2
-6.7
-7.2
-5.8
-8.7
-4.9
-7.0
-5.0
-7.6
-6.5
-6.3
Net financial
liabilities
2017
1.4
-1.6
2.6
2.4
2.3
-1.7
1.4
0.0
-0.2
0.3
-3.2
2.7
3.3
3.6
-3.1
-1.0
1.4
2007
-7
31
73
23
-8
34
43
70
-1
87
80
-45
28
-13
17
44
-1
2010
0
43
86
33
3
57
57
83
37
102
107
-42
38
-8
33
63
7
Gross financial
liabilities
2017
-1
48
61
18
-5
61
43
65
39
87
114
-30
24
-17
47
64
1
2007
15
62
88
64
38
70
65
103
54
112
167
10
51
26
52
71
32
2010
21
79
106
82
39
94
84
112
109
127
200
21
77
33
64
90
41
2017
21
84
81
67
18
99
71
94
110
112
208
8
63
24
78
91
21
Debts, deficits and stylised consolidation
Fiscal trends in the stylised medium-term scenario
As a percentage of nominal GDP
Financial
balances
Fiscal challenge
2007
Seven years of
consolidation
Ireland
Spain
United Kingdom
United States
Euro area
Total of above
countries
2010
Net financial
liabilities
2017
2007
2010
Gross financial
liabilities
2017
2007
2010
2017
0.2
2.2
-2.7
-2.9
-0.7
-13.6
-9.6
-14.0
-11.2
-7.0
-5.0
2.7
-5.6
-0.5
0.7
0
19
29
43
44
38
43
61
69
58
82
40
97
74
53
28
42
47
63
71
80
68
89
98
89
125
66
125
103
85
-1.4
-8.8
-0.5
39
60
63
74
100
104
The impact on potential is a level effect – so growth recovers with
financial hardship. Productivity impact through endogenous growth effect
would be long-lasting growth effect.
Co-ordinated consolidation
Table 4. The effects of single-country and synchronised fiscal consolidation
Fiscal consolidation equivalent to 1% of own-country GDP
Fiscal challenge
Impact of change on
Source of change:
United States
Japan
Euro area
OECD
Spillover as % of own-country
effect
United
Japan
Euro area
States
GDP effects, % diff from baseline
first year
-0.9
-0.2
-0.1
0.0
-0.8
0.0
-0.1
-0.1
-0.8
-1.2
-1.3
-1.1
26%
54%
Total
OECD
-0.5
-0.2
-0.3
-1.1
Of which1
"own
country"
-0.3
-0.1
-0.2
32%
1. "Own country" effect corresponds to the own country multiplier weighted by is share in OECD GDP. The "spillover" is
calculated as the effect of other OECD countries consolidation on own-country GDP as a share of the total GDP effect on
that country when all OECD countries consolidate at the same time.
Source: OECD Global Model
Tentative conclusions and further questions
• Current estimate is of a permanent fall in OECD-wide
level of potential by 3% +
Conclusions
• Main identified effect via higher cost of capital=> capital
intensity
• Hysteresis effects on NAIRU, wide cross-county variation
 Policy dependent, different (better) this time?
• Possibly large negative effects on participation
 Evidence from Nordics of hysteresis-type effects.
 Young most vulnerable (but less concern if more education?)
 But loss of pension wealth lead to retirement postponement?
• Sign & size of TFP effects difficult to identify
More likely to be positive if product market competition strong?
R&D channel probably small?
possibly large if endogenous growth considerations are
important ???