3. Implications of the Fall in Potential Output for Macroeconomic Policies
- International Monetary Fund. European Dept.
- Published Date:
- September 2009
Potential output is falling in the aftermath of the crisis, although the extent of the drop is uncertain. Monetary policymakers should take into account the reduction in potential output and the surrounding uncertainty by clearly communicating their views on potential output and their intent to adjust as new information becomes available. This approach will help anchor expectations for inflation and limit the costs of policy mistakes. Fiscal policy has to absorb the double blow dealt by the crisis to potential growth and debt levels. Even under very benign assumptions about the path of potential output, the required fiscal adjustment will be large, suggesting that policymakers should err on the side of caution and start the necessary consolidation as soon as the state of the cycle allows.