The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Helge Berger, Thomas Dowling, Sergi Lanau, Mico Mrkaic, Pau Rabanal, and Marzie Taheri Sanjani
INTERNATIONAL MONETARY FUND
Potential output-in the sense of the GDP level or path an economy can sustain over the medium term-is a crucial benchmark for policymakers. However, it is difficult to estimate when financial 'booms and busts' are driving the real economy. This paper uses a simple multivariate filtering approach to illustrate the role financial variables play in driving potential or sustainable output. The results suggest that it moves more steadily during financial 'boom and bust' periods than implied by conventional HP filter estimates, which tend to more closely follow actual GDP. A two-region, multisector New Keynesian DSGE model with financial frictions sheds light on the economic forces that could be behind the results obtained from the filter. This has important implications for policymakers.