Growth beyond imbalances. Sustainable growth rates and output gap reassessment

‘The Great Recession’ was preceded by a prolonged period of high growth accompanied by low and stable inflation, the so called ‘Great Moderation’. During that period, potential growth estimates were trending upwards and output gaps remained small. However, other imbalances were progressively accumulating, eventually bringing about the worst crisis in decades. Standard potential growth estimates, which consider inflation as the only indicator of macroeconomic imbalances, along with the stability of inflation in that period, therefore provided misleading signals to policymakers. This paper introduces a methodology to obtain sustainable growth rates, as an alternative measure to potential growth. Sustainable growth is defined as the output growth that does not generate or widen macroeconomic imbalances, identified through a wide set of domestic and external indicators. This allow us to reassess the behavior of output gaps in the US, the UK, Spain, Germany and China both in ‘the Great Moderation’ period and during ‘the Great Recession’. In countries with large imbalances, sustainable growth rates are more stable than potential growth resulting in output gaps that were substantially larger in the period prior to the crisis.