Double-Conditioned Potential Output

The central argument of this paper is that both - internal and external - equilibria should be taken into account in the estimation of potential output. If only the data on inflation, unemployment rate, and wages are used for its evaluation, no certainty exists that such a level will correspond to a stable foreign trade balance. 
Our attempt is based on the following methodological assumptions: 
· the potential output is concomitantly associated with a constant inflation and sustainable relative foreign trade balance (ratio of net export to gross domestic product); 
· all supply shocks affect this level, potential output being, therefore, a variable indicator; 
· consequently, the output gap reflects exclusively the demand pressure. 
The proposed computational algorithm is based on the use of orthogonal regressions. It is exemplified on seasonally adjusted quarterly statistical series of variables charaterizing the Romanian transition economy; this application shows that the estimated output gap does contain significant regular and irregular cyclical components.
* Paper prepared for the 28th General Conference of The International Association for Research in Income and Wealth, Cork, Ireland, August 22 - 28, 2004.

Keywords: Potential Output, Output Gap, Orthogonal Regression, Cycle

JEL Classification: C22, E23, E32