The Potential GDP is a very attractive theoretical concept for economists to measure the maximum level of production that a country can achieve with labor, capital and existing technology, without causing inflationary pressures. Actual GDP and Potential GDP often differ. The difference between the two is called output gap. In upturns, economic activity is maintained for a period of time at the top of its production, generating a positive output gap with inflationary pressures. In recessions, the opposite happens: the economic activity falls below its potential level and the output gap is negative, characterizing adjustment periods in the activity generated downwarding inflationary pressures.
It is a key indicator to judge if deflationary risks are relevant or have to start worrying about inflation. To assess whether expansionary fiscal policies have gone too far or even to anticipate whether the next cycle will start getting endorsed. Therefore, it is essential to design “exit strategies” of the current economic policy or to anticipate the behavior of financial markets. The problem is that the potential growth is not an observable variable and for statistical estimation methods or assumptions are subject to different economic models used, so that the results can be very sensitive to the method chosen.
A broader complicated exercise is when we are emerging from a crisis that may be leading to changes in the economic structure. This transition to a new model of growth is usually slow. The reallocation of resources it is something that takes time, and results are not seen immediately. Usually these changes lead to a decrease in potential growth. Usually lower the short-term capacity to create jobs, as well as less use of “stock” of capital.
The Organization for Economic Cooperation and Development estimates that financial crises reduce the potential growth by at least 1.5 pp on average. It uses data from 30 developed economies from 1960-2007 and shows that the results are robust to the estimation methodology used. The European Commission, in its quarterly report for EMU 2Q-09, also lowers the potential growth of the euro area for 2009 and 2010 to 0.7% from 1.3% in 2008 (1.8% on average during 2000 -2006) as a result of a structural increase in unemployment and a reduction in the contribution of capital.
In the case of the Spanish economy, it seems unlikely that the potential GDP may be higher at this time to 1.5% -2%. So much of the developed countries could emerge from this crisis with lower potential growth by about 30% to those in the period 2000-2006, with the subsequent increase in the natural rate of unemployment. Adjustment offset that potential growth is the main strategic challenge for economic policy and where authorities should concentrate their efforts from now. That situation sometimes involves structural reforms. The monetary valuation of GDP can be given under market price (including subsidies and indirect taxes) or according to factor costs.
There are various classifications of GDP. Which is known as nominal GDP, for example, it represents the financial value that is obtained by adding the services and goods produced by an economic system in current year values that were manufactured or produced. This allows measurements of GDP over time, to avoid distortion produced from inflation. Real GDP character, however, is the absolute monetary valuation at constant values (according to the price of an annual period used as a reference point).