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Potential growth is defined here as the level of output that can be produced without undue strains on productive resources, i.e. without inflationary impact.
Oliner and Sichel (2008) breaks down productivity growth as:
where dx refers to the difference of the logarithm of x, yl is labor productivity, kl is the capital-labor ratio, dkl represents capital deepening, and α is the elasticity of output to capital. The superscripts I and O represent information technology and other types of equipment, respectively. Thus, the first two terms in the right-hand side represent capital deepening in these two types of equipment; tfpI and tfpO refer to TFP growth in sectors producing information technology equipment (and embedded semiconductors) and in other sectors, respectively, already scaled for their share in total production value and corrected for adjustment costs and factor utilization; and q refers to labor quality.
Previous research corroborates the view that potential output growth would decline for several years after a financial crisis, although its longer-term path depends on other key variables, like institutional reforms and political stability. For examples, see Cerra and Saxena (2008), and Furceri and Mourougane (2009).
The resulting rule of thumb is that the indirect effect corresponds to two-thirds of the direct shock.
The correlation between (i) the output correlation between manufacturing sectors and finance and insurance, and (ii) the ranking in external finance dependence is 0.35. Data on dependence in external finance for each manufacturing sector are from Rajan and Zingales (1998).
where dx refers to difference of the logarithm of x, y is output, ks is the capital stock, ku is capital utilization, l is total labor hours, h is average hours of work, u is the unemployment rate, lfp is the labor force participation rate, wap is working-age population, and tfp is total factor productivity. Variables with a * are trend values. All variables refer to the whole U.S. economy and were constructed using information from Haver Analytics and the Organization for Economic Co-Operation and Development (OECD). TFP growth is obtained by applying formula (2) using the level of capacity utilization in the industry calculated by the Federal Reserve Board as a proxy for economy-wide capital utilization and the average share of labor compensation in value added in the past 30 years (about 0.7 in the United States) as a proxy for (l-α). Once TFP growth is obtained, HP filters were applied to capture trend values. Other trend values were obtained by using an HP filter and formula (3) is used to calculate potential GDP growth (Figure 4). The HP filter used for all series assumes a smoothness parameter, λ, of 100—the traditional value for annual-frequency data.
This is consistent with an average duration of capital stock in the United States of about 20 years, as reported in the official statistics.
The authors estimate time-varying NAIRUs for a panel of OECD economies using Phillips curve equations and Kalman filter techniques.
The authors estimated a detailed model combining developments in labor force attachment for particular age-sex groups and demographic changes. Their results show a faster contraction in labor force participation than forecasts done at the time by the Congressional Budget Office, the Bureau of Labor Statistics, and the Social Security Administration Office, although these agencies also anticipated a noticeable downward trend in participation rates.
Projecting trend TFP becomes more uncertain during extreme episodes like the current turmoil. In one hand, the sharp contraction of the housing and financial sector induces costly factor reallocations that, at least in the short term, will hurt total factor productivity. On the other hand, exceptional circumstances triggered by the financial meltdown favor structural reforms that may enhance TFP in the medium to long run. As pointed out by Haugh et al. (2009), financial crises usually have negligible effects on trend TFP for industrial countries over horizons of 5 to 10 years. Nonetheless, the authors stress that trend TFP was adversely affected in Japan during its banking crisis in the 1990s (probably due to the protracted resolution of the difficulties faced by the financial system and the associated inefficiencies resulting from the misallocation of factors).