Mind the Gap: Computing Finance-Neutral Output Gaps in Latin-American Economies

We compute a measure of the finance-neutral potential output for Colombia, Chile and Mexico. Our methodology is based on Borio et al (2013, 2014) and incorporates the cycle of credit, house prices and the real exchange rate on the computation of the output gap. The literature on business cycles in emerging market economies, particularly papers focusing on Latin American economies, has highlighted the importance of including shocks to the interest rate in world capital markets together with financial frictions; terms of trade fluctuations; and a procyclical government spending process. Our results show that around the financial crises of the 1990s the finance-neutral output gap behaved differently than the traditional measures observed by policymakers. In particular, gaps are higher before crises and lower after them.