Estimating Potential Output, Output Gaps and Structural Budget Balances

This paper reviews the methods used for estimating potential output in OECD countries and the use of the resulting output gaps for the calculation of structural budget balances. The "split time trend" method for estimating trend output that was previously used for calculating structural budget balances is compared with two alternative methods, smoothing real GDP using a Hodrick Prescott filter and estimating potential output using a production function approach. It is concluded that the production function approach for estimating potential output provides the best method for estimating output gaps and for calculating structural budget balances, with the results obtained by smoothing GDP providing a cross check. New tax and expenditure elasticities, along with the potential output gaps, are used to derive structural budget balances ...