Measuring Potential Output for the S outh A frican Economy: Embedding Information About the Financial Cycle

Abstract

Abstract Borio et al. show that information embedded in the financial cycle can serve to improve measures of potential output and output gaps. They show that incorporating information on the financial cycle yields measures of potential output and output gaps for the United States, United Kingdom and Spain that are estimated more precisely and are more robust in real time. With its well‐developed financial markets and relatively open capital markets, the South African economy is potentially susceptible to the build‐up of the sort of financial imbalances that characterised the recent financial crisis. Using the framework developed in Borio et al., a finance‐neutral measure of the output gap is estimated for South Africa. The traditional Hodrick–Prescott filter is extended to incorporate information on credit and property prices. Including financial cycle proxies result in output gaps that are estimated more precisely and are more robust to data revisions and the arrival of new data points (i.e. estimated output gaps are more robust in real time), while also reflecting the impact of financial variables on economic activity. As such, the estimated finance‐neutral output gap seems to represent a more appropriate measure on which to base monetary policy decisions.

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