Output Gap in Transition Economies Using Unobserved Component Method: The Case of Czech Republic, Estonia and Kosovo
Ekonomska misao i praksa, No. 2, 2017
24 Pages Posted: 2 Nov 2019
Date Written: 2017
This paper investigates the concept and estimation of the output gap in transition economies, with special reference to the Czech Republic, Estonia and Kosovo. The motivation for investigating this phenomenon lies in the macroeconomic imbalances characterizing many transition economies, such as relatively sluggish growth, chronic balance of payments deficits and structural deficiencies, while continuously operating in the presence of relatively large underutilized resources. Given that the potential output and the corresponding output gap concepts are mainly discussed in the light of mainstream theories, the novelty of this paper stands in examining the relevance of the output gap in transition context. In order to reflect persistent underutilized resources as well as several structural breaks, the Unobserved Components model operationalized via the Kalman filter was employed as a the appropriate estimation method for transition economies. Another novelty of this study is the textual explanation of the technicalities underpinning the Kalman filtering procedure. While causing the output to fall below its potential, the results suggest that the Global Financial Crisis (GFC) had a significant but transitory impact in the Czech Republic and Estonia cases. Due to relatively low external exposure and domestically funded banking system, the GFC caused no recession in Kosovo, but rather slowed the pace of growth mainly via the external sector channels and the uncertainties perceived by the banking sector. Last, the negative relationship between inflation and output gap was informative in the case of the Czech Republic and Estonia because it suggested a presence of inflation inertia in these countries, whereas the impact of the output gap on the inflation rate in Kosovo proved insignificant.
Keywords: Output Gap, Unobserved Components Model, Kalman Filter, Transition Economies
JEL Classification: E32, C32, P2
Suggested Citation: Suggested Citation