Excess Capacity and Hysteresis in EU Countries. A Structural Approach

We develop an original method for identifying the structural parameters of the production function and estimate the rate of capacity utilization in 12 EU countries. Our results provide evidence of persistent excess capacity and hysteresis in many EU countries, especially after the 2008’s global financial crisis. Parameters are correctly identified, stable and robust to alternative specifications. Moreover, our series of capacity utilization explain inflation as much – or even more – efficiently than the official series of capacity utilization and output gaps provided by the European Commission. We thus support the claim that larger fiscal deficits may have absorbed unemployment without producing persistent inflationary pressures