ESTIMATING THE OUTPUT GAP FOR TURKEY: A SIMPLE PRODUCTION FUNCTION APPROACH MURAT ÜNGÖR

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1 ESTIMATING THE OUTPUT GAP FOR TURKEY: A SIMPLE PRODUCTION FUNCTION APPROACH MURAT ÜNGÖR Research and Moneary Policy Deparmen Cenral Bank of he Republic of Turkey ABSTRACT This paper esimaes an oupu gap measure for Turkey using a producion funcion approach relying on a simplisic represenaion of he producion echnology. There is a large posiive swing in he oupu gap during and oupu gap reached is peak in 2007:Q4. Oupu level fell below is poenial dramaically as a resul of he global economic crisis in 2009 hiing a rough in 2009:Q1 and negaive oupu gap as a percenage difference from he poenial oupu was around 12%. Oupu gap esimaes in his sudy and he ones obained in Alp, Öğünç, and Sarıkaya (2012), using Bayesian esimaion of a New Keynesian model, exhibi a similar paern qualiaively, whereas here are some differences in quaniaive erms. Keywords: Oupu gap, producion funcion, Turkey. JEL classificaion numbers: E23, E32, E58. Correspondence: Mura Üngör, Research and Moneary Policy Deparmen, Cenral Bank of he Republic of Turkey, İsiklal Caddesi 10, Ulus, Ankara, Turkey. address: Mura.Ungor@cmb.gov.r. The auhor wishes o hank Harun Alp, Cengiz Cihan, Ufuk Demiroğlu, Mahmu Günay, and Şeref Saygılı for sharing daa and Musafa Kılınç for fruiful discussions. The views expressed herein are hose of he auhor and no necessarily hose of he Cenral Bank of he Republic of Turkey. 1

2 I. INTRODUCTION Turkey has grabbed he aenion of inernaional economics as he counry has shown high growh raes in recen years. Today, Turkey is an upper middle income counry wih a populaion around 75 million and a gross domesic produc around US$800 billion, making i he 16h larges economy in he world. Turkey s GDP growh rae in 2010 averaged abou 9% ranking i in firs place in Europe and i acceleraed o 11% in he firs quarer of 2011 oupacing China s growh rae. The recen economic performance of he Turkish economy provides moivaion for he measuremen of oupu gap in Turkey o be used for forecasing and policy simulaions. For example, reasonably accurae oupu gap esimaes are necessary o conduc moneary policies since cenral bankers would like o know he size of he gap beween acual and poenial GDP, so as o deermine wheher he economy needs more or less moneary simulus. This paper presens a simple way of oupu gap calculaion for Turkey based on he producion funcion and he HP filering. 1 II. METHODOLOGY AND DATA A producion funcion saes a relaionship beween inpus (like labour and capial) and oupu (goods and services combined). The producion funcion approach models poenial oupu as a funcion of poenial labour and capial inpus, as well as of poenial oal facor produciviy (TFP). Therefore, oupu gap measures how far he economy is from is full employmen or 1 For earlier sudies on oupu gap esimaion in Turkey wih differen mehods, see Öğünç and Ece (2004), Kara, Öğünç, Özlale, and Sarıkaya (2007), Saygılı and Cihan (2008), Öğünç and Sarıkaya (2011), Alp, Öğünç and Sarıkaya (2012) and he references herein. 2

3 poenial level ha depends on supply-side facors of he economy: he supply of labour and capial and heir produciviy. Oupu gap is defined as he percenage difference beween acual and poenial oupu: Oupu Acual oupu Poenial oupu gap = 100 (1) Poenial oupu and acual oupu is given by: Y = A K L (2) α 1 α where Y represens real gross domesic produc (GDP), A is TFP, K is real physical capial sock and L is employmen a dae ; α and ( 1 α ) are he elasiciies of oupu wih respec o capial and labour, respecively. Similarly, poenial oupu is given by: α 1 α L Y = A K (3) where and Y represens poenial GDP, L is poenial employmen a dae. A is poenial TFP, K is poenial physical capial sock The idea is, using minimum available informaion on he supply side of he economy (oal employmen and physical capial), o infer useful informaion for measuring he oupu gap for he Turkish economy. In his regard, his sudy depars from radiional producion funcion approach in which labour variable (raher han employmen) is esimaed by aking ino accoun 3

4 labour supply (usually linked o working-age populaion growh, paricipaion rae and working hours) and NAIRU (or srucural unemploymen rae), and capial sock variable is used as acual values or correced by using capaciy uilizaion raes. 2 Capial sock, employmen, and real GDP daa are from Saygılı and Cihan (2011). Saygılı and Cihan (2011) have seasonally adjused quarerly daa beween 1988:Q1 and 2011:Q2. This sample period is exended o 2014:Q4 o avoid end-sample biases, which reflec he symmeric rending objecive of he mehod across he whole sample and he differen consrains ha apply wihin he sample and a is edges. 3 The nex sep is calculaing TFP series using capial sock, employmen, and real GDP daa: α 1 α ( K L ) A = Y (4) where α = 0. 5 is used following Saygılı and Cihan (2011).4 Then, using a growh accouning mehod, he conribuions of capial, labour, and TFP ino real GDP growh are calculaed. 5 I is assumed ha hese calculaed conribuions for he period 2002:Q1-2011:Q2 will be valid hrough 2014:Q4. Nex, using he forecass for quarer-onquarer growh raes of GDP, consisen wih he official forecass, he real GDP series are exended o 2014:Q4. Afer ha, he growh conribuions of capial, labour, and TFP for he 2 Saygılı and Cihan (2008) sudy such a producion funcion approach and repor poenial and acual growh raes beween 1987 and The poenial oupu esimaes, using annual capial and employmen daa, obained in his paper are compared wih he ones obained in Saygılı and Cihan (2008), who use capaciy uilizaion raes, average working hours, and NAIRU figures o calculae poenial oupu. The resuls are very similar. 3 This flaw is paricularly severe when he focus of aenion is direced a he mos recen observaions in he sample in an effor o draw conclusions for policy implemenaion and make projecions for he immediae fuure (see, for example, Cerra and Saxena, 2000). 4 See Ismihan and Mein-Özcan (2009) on he value of capial income share in Turkey. 5 This growh accouning exercise is carried ou wih annual daa (wih human capial inpu) as well. The resuls are available upon reques. 4

5 period 2011:Q3-2014:Q4 are used o exend hese series unil he las quarer of Now, capial, labour, TFP, and real GDP series for he period 1988:Q1-2014:Q4 are available o be used for calculaions. Poenial oupu canno be measured direcly and herefore mus be esimaed. The HP filer is applied, using he sandard value of 1600 for he smoohing parameer, o acual capial, labour, and TFP series separaely. Then, he rends underlying he series of acual labour as poenial labour inpu, acual capial as poenial capial inpu, and acual TFP for poenial TFP are used. Fig. 1 provides acual and poenial daa for capial, labour, and TFP for he period 2003:Q1-2014:Q (a) Capial Sock Poenial Acual Poenial Acual (b) Employmen (c) TFP Poenial Acual Fig. 1. Acual and poenial series, 2003:Q1 = 100 5

6 Acual TFP growh exceeds he esimaed poenial TFP growh by a wide margin during beween 2003 and Ismihan and Mein-Özcan (2009) lis four facors ha could have been responsible for he speed-up in TFP: (i) successful reducion of he inflaion rae, fiscal discipline, and he resulan sable macroeconomic environmen; (ii) insiuional reforms o he cenral bank and public-secor spending and srucural reforms o he financial secor; (iii) he relaively sable poliical and exernal environmen; and (iv) he prospec of possible EU membership. 6 Finally, poenial employmen ( L ) and poenial capial ( K ) inpus and poenial TFP ( A ) in equaion (3) are used o esimae poenial oupu. III. OUTPUT GAP Fig. 2(a) presens quarer-on-quarer growh raes for poenial oupu and Fig. 2(b) displays he oupu gap esimaes based on he producion funcion for he period 2003:Q1-2014:Q4. There is a large posiive swing in he oupu gap during Oupu gap reached is peak in 2007:Q4 and oupu level fell below is poenial dramaically as a resul of he global economic crisis in Oupu level hi a rough in 2009:Q1 and negaive oupu gap as a percenage difference from he poenial oupu was around 12%. 7 Afer he crisis, Turkish economy has enered a rapid recovery period. In he succeeding period oupu gap has sared o decline compared o he year of 2009, he negaive gap closed indicaing he conribuion of oupu gap o disinflaion process has been diminishing compared 6 Since 2001, Turkey has pu in place a very inense and ambiious srucural reform agenda, coupled wih sound moneary and fiscal policies, o esablish macroeconomic and financial sabiliy and o improve he business environmen. 7 An alernaive way in he lieraure o calculae poenial oupu is assuming ha poenial capial equals he acual oal capial sock (see, for example, Konuki, 2008). Oupu gap is also calculaed wih acual physical capial series as poenial capial sock. The resuls are very similar. 6

7 o he global crisis era. These oupu gap esimaes poin ou similar expansion and recession periods and are close o previous sudies by Saygılı and Cihan (2008), Öğünç, and Sarıkaya (2011), and Alp e al. (2012). Fig. 2(c) compares he oupu gap esimaed in his paper wih he findings of a recen sudy for he period 2003:Q1-2011:Q3. Alp e al. (2012) esimae an oupu gap measure for Turkey in a Bayesian framework considering a sylized New Keynesian small open economy model ha describes he join deerminaion of oupu gap, is domesic and exernal componens along wih inflaion. Fig. 2(c) reveals ha, he oupu gap esimaes in his sudy and he ones obained in Alp e al. (2012) exhibi a similar paern qualiaively, whereas here are some differences in quaniaive erms. For example, i is esimaed ha oupu level hi a rough in 2009:Q1 and negaive oupu gap as a percenage difference from he poenial oupu was 11.84%. The corresponding figure in Alp e al. (2012) is 11.71%. Fig. 2(d) provides alernaive esimaes of oupu gap using differen smoohing parameer for he HP filer since a possible shorcoming of using he HP filer is he difficuly in idenifying he appropriae smoohing parameer, which is generally overlooked by using arbirary values popularized by he real business cycle lieraure. Alp e al. (2011) esimae he opimal smoohing parameer for he HP filer for Turkey using quarerly real GDP daa beween 1987 and They come up wih wo alernaive esimaes (compared o 1600, which is he benchmark smoohing parameer used in his sudy): 19 and 98. Therefore, he calculaions are replicaed o see he sensiiviy of he resuls wih respec o he smoohing parameer. I is observed ha he qualiaive naure of he resuls is similar. However, he smaller he value of he smoohing 7

8 parameer, he closer he oupu gap o zero. If 19 (98) is used as he value of he smoohing parameer, hen oupu level hi a rough in 2009:Q1 and oupu gap was -7.66% (-9.47%). (a) Poenial Growh (%) (b) Oupu Gap (%) (c) Oupu Gap (%): A Comparison This Sudy Alp, Öğünç, Sarıkaya (2012) 2003Q4 2004Q3 2005Q2 2006Q4 2007Q3 2008Q2 2009Q4 2010Q3 2011Q2 (d) Oupu Gap (%): A Sensiiviy Analysis 8 4 HP 19 HP 98 HP Q4 2004Q3 2005Q2 2006Q4 2007Q3 2008Q2 2009Q4 2010Q3 2011Q2 Fig. 2. Acual and poenial oupu IV. CONCLUSIONS This sudy can be considered a preliminary sep o measure he oupu gap for he emerging marke economies using minimum available informaion on he supply side of he economy. Any mehod of esimaing poenial oupu depends on numerous assumpions ha are subjec o 8

9 uncerainy and error. The approach in his sudy relies on a simplisic represenaion of he producion echnology omiing he direc informaion regarding he relaed supply-side facors such as capaciy uilizaion, hours worked, labour force paricipaion rae, echnology adopion, regulaion, human capial accumulaion, ec. in addiion o he alernaive filering mehods. However, he obained resuls are fairly comparable wih he ones obained in more complicaed sudies (see Fig. 2(c)) suggesing ha he approach used in his paper could be useful as an alernaive mehod of oupu gap esimaion for Turkey and, possibly, for oher emerging marke economies. REFERENCES Alp, H., Başkaya, Y. S., Kılınç, M. and Yüksel, C. (2011) Esimaing opimal Hodrick-Presco filer smoohing parameer for Turkey, İkisa İşleme ve Finans, 26, Alp, H., Öğünç, F. and Sarıkaya, Ç. (2012) Moneary policy and oupu gap: mind he composiion, Cenral Bank of Turkey Economic Noes, 12/07. Cerra, V., and Saxena, S. C. (2000) Alernaive mehods of esimaing poenial oupu and he oupu gap: an applicaion o Sweden, IMF Working Paper, WP/00/59. Ismihan, M., and Mein-Özcan, K. (2009) Produciviy and growh in an unsable emerging marke economy: he case of Turkey, , Emerging Markes Finance and Trade, 45, Kara, H., Öğünç, F., Özlale, Ü. and Sarıkaya, Ç. (2007). Esimaing he oupu gap in a changing economy, Souhern Economic Journal, 74, Konuki, T. (2008) Esimaing poenial oupu and he oupu gap in Slovakia, IMF Working Paper, WP/08/275. Öğünç, F., and Ece, D. (2004) Esimaing he oupu gap for Turkey: an unobserved componens approach, Applied Economics Leers, 11, Öğünç, F., and Sarıkaya, Ç. (2011). Invisible bu no impercepible: oupu gap in Turkey, Cenral Bank Review, 11, Saygılı, Ş., and Cihan, C. (2008) Türkiye ekonomisinin büyüme dinamikleri: döneminde büyümenin kaynakları, emel sorunlar ve poansiyel büyüme oranı, TÜSİAD (in Turkish). Saygılı, Ş., and Cihan, C. (2011) döneminde Türkiye ekonomisindeki büyümenin arz yönlü dinamikleri: çeyreklik ve yıllık bazda analizler, Unpublished Manuscrip (in Turkish), Cenral Bank of Turkey. 9