Output Gap and NAIRU

An accurate identification of the output gap, comprehensive concept for the
measurement of the cyclical position of the economy, is necessary for the
formulation of prudent macroeconomic policies. However, this indicator is
unobservable in practice and therefore is subject to the estimation difficulties. For
the purpose of the Ministry of Finance of the Slovak Republic, its estimates are used
for the calculation of the cyclically-adjusted public finance deficit, which is required
for the assessment of the stability and convergence programme. The MoFSR uses
the conventional production method for the calculation of the output gap.
Considering that significant FDI inflow in pre-crisis years injected volatility in the
potential output growth, the MoFSR has included experts’ adjustments to the
production function methodology. In this paper, we aim to validate these
adjustments by developing an alternative model for the output gap estimation. The
multivariate Kalman filter framework is used as it secures flexible modeling
environment and allows for simultaneous goods and labour markets interactions.
As an additional product, we obtain the NAIRU estimates,which is an useful
information for the formation and evaluation of labour market policies. We conclude
that estimates derived from the model confirm our hypothesis that experts’
adjustments to the standard production function are necessary to produce result in
line with other observed economic indicators. Finally, by identifying the negative
demand shocks from current economic and financial crisis, we try to evaluate the
estimated loss on the potential output stemming from the global downturn.
Alongside with this, we project a recovery of the potential output growth rate to its
‘equilibrium’ rates. The calculations support a widely shared consensus that the
pace of the potential growth will decelerate compared with previous decade.