Saturday, February 12, 2011

On Turkey's output gap

A reader has written the following as a comment to my post on industrial production and Turkey's output gap:
I disagree with any of the "rapidly closing output gap" or "overheating economy" arguments. Industrial production constitutes only 30% of the total economy and the correlation does not necessarily imply causality as you know it better than I am. The diffusion effect of industrial sector dynamics to services sector may take more time than you expect. Moreover, backward linkages may not be strong as much as you think. In order to comment on a gap, one has to specify a correct reference point, which is the "potential output" in this case. Given the developments in Turkish economy over the last decade, I think CBT's "negative output gap" argument might have a more profound significance. Let me put it this way: Turkish economy would have grown by 60% since 2003, if the real GDP had increased by 6% each year. However, by the end of 2010, Turkish economy is estimated to have grown by 45% since 2003. I believe this could be one reason that why Turkish economy might still has a negative output gap.
First of all, I should thank the reader for illustrating so well the case against the rapidly closing output gap. All her arguments have a merit, but let me add one footnote: Indicators other than industrial production are signaling overheating as well: For example, have a look at the demand indicators my good friends at Turkey Data Monitor have compiled:
The picture does not change if you look at it in a quarterly format:
At the end of it, as this argument boils down to what Turkey's potential output/growth is, and as a corellary what the Turkish NAIRU is. I have discussed both issues quite a few times in the blog, for example, see here and here.

But the reader's comments illustrate that there is quite a compelling case, as argued by the CBT, that the output gap has a long way to go. I don't buy it, but the case is still there!...

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