The Stability and Growth Pact (SGP) is a rule-based framework for the coordination of national fiscal policies in the economic and monetary union (EMU). It was established to safeguard sound public finances, an important requirement for EMU to function properly.
The concepts of potential growth and output gap form a crucial part of the toolkit for assessing the cyclical position of the economy and its productive capacity. Potential growth constitutes a summary indicator of the economy's capacity to generate sustainable, non-inflationary, growth, whilst the output gap is an indication of the degree of overheating or slack relative to this growth potential. These concepts have become an essential ingredient of the fiscal surveillance process emanating from the SGP.
Estimating the output gap is difficult since potential growth is not directly observable. The estimates obtained from the ECOFIN Council approved production function methodology have been providing essential information to policy makers since their initial release in 2002.
The JRC has implemented this methodology into the estimation platform GAP that is currently used by the European Commission to calculate output gap and potential output. This information has been used by policy makers for their ongoing discussions regarding the appropriate mix of macroeconomic and structural policies in the various EU economies, with the former geared to eliminating cyclical slack and the latter being used to raise the output potential of their respective economies.
Econometric and Statistical Sofware tools
The production function methodology for calculating potential growth rates and output gaps
The information content of capacity utilization for detrending total factor productivity