Svante Öberg: GDP growth and resource utilisation
Speech by Mr Svante Öberg, First Deputy Governor of the Sveriges Riksbank, at Statistics
Sweden's annual conference, Saltsjöbaden, 6 October 2011.
* * *
It's a pleasure to be back here in Saltsjöbaden again. It has now been ten years since I was
involved in starting these annual conferences as the head of Statistics Sweden. In those
days, this was a matter of improving economic statistics. What several of the proposals we
discussed had in common was that they were important for our efforts to elucidate and
understand productivity growth. These proposals included a better price index in the private
service sector, better capital stock calculations, better input-output statistics and better IT
statistics. I also considered that Statistics Sweden should do more to describe and analyse
productivity growth. I am therefore very pleased to see that the conferences have come to
focus on the important area of productivity growth and its causes.
My speech today can be summed up in the following three points:
 Resource utilisation can be measured in several different ways, among others as
actual GDP in relation to potential GDP (the GDP gap).
 The financial crisis has lowered the growth rate of potential GDP.
 Resource utilisation is thus largely normal, even though GDP is only slightly higher
than before the crisis.
I will start by describing GDP growth over the longer term. Then, I will address resource
utilisation's significance for monetary policy, give an account of the Riksbank's calculations of
potential GDP, discuss the impact of the financial crisis on potential GDP, give an account of
different measures of resource utilisation and what they say about resource utilisation at
present, and conclude by addressing the need for continued analyses.
GDP grows over time, but the rate of growth varies
GDP growth since 1950 is illustrated in Figures 1 and 2. What is known as an HP trend is
also included in the figures. I will return to these HP trends later. Seen over the entire period
from 1950 to 2010, GDP has increased by an average of 2.7 per cent per year. Growth was
significantly stronger in the 1950s and 1960s compared with the 1970s and 1980s. There
then followed a ten-year period from the mid-1990s with relatively rapid GDP growth and
associated relatively rapid productivity growth.
In earlier seminars, we have discussed the reasons for the strong productivity growth during
this later period. I myself have pointed out a number of possible explanations.1 Globalisation
through the expansion of the EU, the opening up of the economies of eastern Europe and
China's rapidly-growing international trade have increased competition, which has been
particularly significant for Sweden, with our substantial foreign trade and high proportion of
international companies. Furthermore, a number of product markets were deregulated in the
1990s (taxis, domestic flights, postal services, telecommunications, electricity etc.). Sweden
also has high proportions of IT production and IT use in production. Last year, we also
discussed the significance of education, work organisation and intangible investments.
In conjunction with the financial crisis, GDP then fell by over five per cent in 2009, before
rising again by over five per cent in 2010. Productivity in the economy as a whole, measured
as GDP per hour worked, decreased for two consecutive years by a total of over four per
cent. I will later address the possible reasons for this and the possible consequences. But I
will start with the significance of resource utilisation for monetary policy.
Resource utilisation is of great significance to monetary policy
According to the Sveriges Riksbank Act, the objective for monetary policy is to maintain price
stability. At the Riksbank, we have interpreted this to mean that we should strive to hold
inflation, measured in terms of the consumer price index, at two per cent per year. We have
been clear about the CPI being the target variable. But we also follow a number of other
inflation measures to analyse and better understand the development of inflation: the CPI
with a fixed interest rate (CPIF), CPIF excluding energy, the EU-harmonised measure HICP
and several measures of underlying inflation.2
There are two reasons for the Riksbank to care about resource utilisation, in addition to price
stability. The first is that we are striving to attain high GDP, high employment and low
unemployment, and resource utilisation is related to these targets. But we should only do this
when it is compatible with the inflation target. The inflation target takes precedence. This
differs from the United States, where the central bank has the double target of achieving
price stability and maximum employment. In addition, the preparatory works for the Sveriges
Riksbank Act only refer to "high" employment (as compared with the United States'
"maximum" employment) and not to any particular level of unemployment.3
The other reason to care about resource utilisation is that it serves as an indicator of future
inflation. The positive relationship between resource utilisation and inflation is illustrated in
Figure 3, which shows the correlation between three different measures of resource
utilisation and CPIF inflation 1-12 quarters ahead.4 The connection is fairly strong
3-8 quarters ahead. The connection is stronger and faster for the hours gap than for the
GDP gap and the RU indicator. This may be because the development of the labour market
usually follows behind output and because it is very important for the development of prices
and wages. Of course, it is difficult to draw any conclusions from the covariation of two
variables, but the same type of relationship also exists in more developed
empiricallyestimated models.
Considering this, we wrote, in Monetary Policy in Sweden, that the Riksbank, in addition to
achieving low and stable inflation, should also strive to stabilise output and employment
around long-term sustainable paths.5 This means that we also strive to hold resource
utilisation at a normal level. We usually say that the Riksbank is thereby conducting a flexible
inflation-targeting policy. We have also chosen to take a broad approach when it comes to
interpreting resource utilisation, instead for only looking at a single measure of resource
utilisation.
The Riksbank's calculations of potential GDP
Resource utilisation can be measured in several different ways. Here, I will demonstrate how
we, at the Riksbank, calculate measurements of resource utilisation based on GDP and
potential GDP, as well as hours worked and potential hours worked. Potential GDP refers to
the level of GDP that is consistent with a use of the available resources that is sustainable in
the long term and that does not push up inflation. If GDP exceeds the potential level, then
resource utilisation is high - and vice versa. We call the difference between actual and
potential GDP the GDP gap.6 When resource utilisation is normal, GDP is equal to potential
BNP, and the GDP gap is equal to zero. Consequently, potential GDP does not refer to the
highest level GDP may reach over the short term.
In Figure 1, the trend development of GDP is represented by a Hodrick-Prescott trend (HP
trend). An HP trend is something between a linear trend and the actual development of GDP.
The HP trend is a common and often fairly good measure of the underlying long-term
development in GDP during normal cyclical fluctuations. But the HP trend is not good at
estimating the underlying development of GDP at the end of a time series and it gives no
guidance as to why output deviates from its trend level.
The production function approach
On the other hand, our ability to analyse why output deviates from its long-term level can be
improved if a production function (PF) approach is used. This is a common technique used by
international organisations such as the IMF and the OECD. The Riksbank has used such an
approach since 2010.7 A production function shows how output depends on production factors
and technological level. In the most common case, we may consider that output (Y) depends
on the number of hours worked (H), the capital stock (K) and total factor productivity (TFP).
The level of TFP determines how much output is derived from a given amount of hours and
capital.8 TFP can thus be seen as a measure of the level of technology. By specifying a form
for the production function, the following breakdown is obtained:9
The wage share in the economy is usually about two-thirds, which is why hours are
considered to stand for two-thirds of the production factors ( ) and capital for the
remaining third ( ). The contribution of each factor to output can then be calculated.
Output increases through more capital weighted by a third, more hours worked weighted by
two thirds and improved TFP.
But, in practice, it is difficult to measure TFP. Instead, it must normally be estimated as a
residual, often called a Solow residual after Nobel Prize winner Robert Solow. The output
that does not depend on the input factors of capital and labour is assigned to TFP.
In accordance with the production function, the potential level of production can also be
divided up into potential total factor productivity, potential capital stock and potential hours.
Deviations from the potential level can be estimated for each of the three factors affecting
output - capital, hours worked and TFP. These deviations can then be weighted together to
give a total output gap.
Calculations of potential GDP
This section describes the calculations forming the basis for the GDP and hours gap
published in the most recent Monetary Policy Update.10
Figure 4 shows an estimate of actual and potential TFP. Actual TFP is estimated with the
Solow residual. The TFP estimate thus captures all change in output that cannot be
explained by the development of capital and hours. Potential TFP is estimated with an HP
trend based on the Solow residual. The idea is that the TFP estimate will describe technical
developments. But, among other factors, it is also affected by the fact that the production
factors' degree of utilisation varies over time. Estimating TFP is thus the most uncertain part
of applying the PF approach. The assessment made was that actual TFP at present was
largely the same as potential TFP.
Figure 5 shows the development of the capital stock or, more precisely, the flow of services
from the capital stock. In this connection, it is assumed that the actual capital stock
corresponds with the potential capital stock. The development of the capital stock in the
period ahead has been based on the Riksbank's investment forecast.
Figure 6 shows the development of the number of hours worked and the potential level of
these. The development of potential hours in the future is determined by demographic
developments, the assumption that there will be a trend increase in labour force participation
among older people and an assessment of the effects of economic policy. These
assessments have led to the potential number of hours worked presently exceeding the
indications of the HP trend.
Figure 7 shows GDP and two measures of potential GDP: the HP trend and the PF
approach. The difference between potential GDP calculated with the HP trend and with the
PF approach is not so large. The most important difference between the measures is the
potential development of hours. In the PF approach, the development of potential hours is
based on assessments with no HP trend element.
Figures 8 and 9 show the measures of resource utilisation based on GDP and potential GDP,
in addition to hours worked and potential hours worked, that were the result of these
calculations. They indicate that resource utilisation is largely normal this year. The GDP gap
based on the HP filter is slightly higher than normal, while the GDP gap based on the PF
approach is slightly lower than normal. The reason for the difference lies in the assessment
of the potential number of hours worked. The hours gap based on the HP filter is slightly
higher than normal, while the hours gap used in the PF approach is slightly lower than
normal.
Difficulties in calculations, but reasonable view of present situation
There are several problems with the method of calculating potential GDP I have just
described. Among others, these include the calculations of potential labour, capital stock and
TFP. The difficulty of assessing potential GDP is also illustrated by the way that assessments
of the GDP gap have changed over time. Attention has been drawn to this, not least by
Orphanides.11 Among other observations, he shows that the estimates of the GDP gap for the
United States for a certain year, made by the International Monetary Fund (IMF), have
changed radically between the various dates of calculation, and draws the conclusion that
GDP growth should be focused on as the basis for monetary policy, rather than the GDP gap.
Figure 10 presents estimates of the GDP gap in real time and in accordance with the most
recent calculation from September 2011. The estimates in real time show what we believed
the current GDP gap to be at the various previous forecasting occasions. The figure indicates
that resource utilisation was higher in the years preceding the crisis than we believed at the
time. However, there are also problems with estimating resource utilisation in retrospect,
which mean that such calculations may perhaps overestimate how high resource utilisation
was before the crisis. I will come back to this.
Despite these difficulties, my assessment is that the Riksbank's calculations of the GDP gap
largely give a reasonable view of current resource utilisation. The decisive factor for this
assessment is that the GDP gap currently corresponds with other ways of measuring
resource utilisation that are based on other economic statistics. These other measures also
show that resource utilisation is largely normal. I will review a number of such measures at a
later point.
In contrast, I do not think that the GDP gap provides a reasonable view of the development
of resource utilisation over the course of recent years. I shall return to this shortly. First,
however, I would like to address the effects of the financial crisis on potential GDP, as this
plays an important role in the assessment of the GDP gap.
The financial crisis has had a negative effect on potential GDP
The financial crisis has probably lowered the potential growth rate.12 There may be several
reasons for this. The capital stock has been negatively affected by the financial crisis through
the decrease of the investment level. Growth in the capital stock has come to a halt. Even
though we expect investments to recover quite strongly in the period ahead, the capital stock
will not reach the pre-crisis trend level.
The labour force has probably also been affected negatively due to exclusion from the labour
market, with competence among the labour force being undermined by long periods of
unemployment. However, this reduction of the labour supply due to the crisis has been more
than counteracted by an economic policy focused on increasing labour force participation.
The number of people in the labour force has increased in recent years due to this.
The most important factor, which is also the most difficult to explain, is that total factor
productivity also fell during the most recent crisis. It is, of course, normal for productivity to
develop less strongly at the start of a recession. But the heavy fall of just over six per cent
that occurred between the third quarter of 2008 and the first quarter of 2009 was abnormally
large. This was probably partially due to a decrease of the degree of utilisation of capital and
labour.
According to Figure 8, actual GDP and potential GDP were largely the same in 1995 and
2005. As the estimate of potential GDP was not seriously affected by terminal point problems
or deep recessions in these years, it probably provides a reasonable view of potential GDP.
This is also supported by data on economic activity that shows that resource utilisation was
largely normal in these years. The average rate of growth in GDP between 1995 and 2005
was 3.1 per cent per year. Consequently, this is also the average rate of growth of potential
GDP during this period.
According to Figure 8, actual GDP and potential GDP were also roughly the same in 2011.
Between 2005 and 2011, both GDP and potential GDP have thus increased by an average of
2.0 per cent per year. A projection of GDP from 2005 according to the earlier trend of
three per cent per year would have given a GDP level about six per cent higher than actual
GDP in 2011. Even if this is only a mathematical example and the potential growth, if there
had been no financial crisis, is assumed to be significantly lower than three per cent per year,
it still shows that the financial crisis put a dent in the long-term upwards development of
potential GDP.13
The lowered rate of growth of potential GDP after the financial crisis corresponds with
international experiences. In conjunction with financial crises, it is normal for GDP growth to
be lower in the ten years following the crisis than in the ten years before the crisis.14
But the financial crisis primarily affected Sweden through reduced exports, not through
problems in the banking sector. It is thus not self-evident that the rate of growth of potential
GDP should necessarily be lower in Sweden. One explanation may be that the rate of growth
of potential GDP does not only decrease in conjunction with financial crises, but also in
conjunction with deep recessions. We have seen in earlier crises, in the late 1970s and early
1980s, as well as in the early 1990s, that a deep recession can have this effect. On these
occasions, GDP did not reach the pre-crisis trend level for the next ten years.15 Another
explanation may be that Sweden, with its high international dependence, cannot isolate itself
too much from developments abroad. There are also rigidities in the economy that mean that
it will take time before a sharp fall in exports can be replaced by an increase of exports or by
an increase of domestic demand that fully compensates for this decline.
I actually think it is more reasonable to concentrate the negative effect on potential GDP to
the period immediately after the start of the financial crisis, rather than to spread it out over a
larger number of years before and after the financial crisis in the way that both the HP trend
and the PF approach do. This would mean that the GDP gap would not appear so high in
2008 and perhaps not so low in 2009 either. But this is unimportant for the assessment of
resource utilisation this year.
Resource utilisation is largely normal
My assessment is thus that resource utilisation is largely normal. The measures of resource
utilisation that I showed earlier in Figures 8 and 9 indicated this. But it is also supported by
other measures of resource utilisation, based on questions to individuals and companies. An
additional advantage of measures of this type is that they can be seen directly in the
statistics, thus avoiding the problems associated with HP trends and PF approaches.
Figure 11 shows such a measure, capacity utilisation in the manufacturing sector from
Statistics Sweden (SCB). It is now more or less on the average level for the period
1996-2008. Another measure of this type is the employment rate from the labour force
surveys (AKU), which shows the proportion of the population of working age that is in
employment. Figure 12 shows that the employment rate this year is close to the average for
the years 2000-2008.
The Riksbank's indicator of resource utilisation (the RU indicator) summarises about thirty
such economic variables regarding levels.16 The RU indicator includes survey data from the
National Institute of Economic Research's Economic Tendency Survey for private services,
the retail trade and the construction and manufacturing industries. In addition, capacity
utilisation in the manufacturing sector from Statistics Sweden, the employment rate and
unemployment from the labour market surveys, and unfilled vacancies from the Swedish
Public Employment Service are also included. According to the RU indicator, resource
utilisation is slightly higher than normal (see Figure 13).
Figure 14 shows unemployment together with an average for the period 2000-2008 and an
assessment of long-term unemployment.17 Seasonally-adjusted unemployment is presently
higher than this long-term level. But assessments of long-term unemployment are fraught
with great difficulties. It is possible that the financial crisis will lead to an increase of long-term
unemployment. At the same time, it is possible that the measures adopted in recent years
will lead to a reduction of long-term unemployment. The net outcome of these two opposing
18
forces will eventually become clear.
At the same time as the unemployment gap is positive (see Figure 15), there is a shortage of
labour in many sectors and in the business sector as a whole (see Figure 16). This indicates
that matching on the labour market has deteriorated. This is also supported by the fact that
the Beveridge curve, which shows the connection between the number of persons
unemployed and the number of unfilled vacancies, has shifted outwards (see Figure 17). The
composition of the category unemployed has also changed. For example, the proportion of
unemployed people with brief and incomplete educations has increased. All in all, for my
part, I interpret this to mean that resource utilisation with regard to labour is also largely
normal.
The most recent Monetary Policy Update included the assessment that resource utilisation
was somewhat lower than normal, but that it would be largely normal towards the end of the
forecast period. My overall assessment at the monetary policy meeting was instead that
resource utilisation was already normal, and I have taken the opportunity to explain my
judgement in a little more depth in this speech. The different measures of resource utilisation
that I have addressed today are summarised in Table 1.
We need more knowledge of productivity growth
Today, I have given you an account of how the Riksbank tries, in various ways, to assess
how large resource utilisation is. One of the measures of resource utilisation that we use
compares actual GDP with an estimate of potential GDP. The financial crisis has probably
lowered the growth rate of potential GDP. Actual GDP is thus roughly equal to potential GDP
at present, even though GDP is only slightly higher than it was before the crisis. My
assessment is also that resource utilisation is largely normal. This assessment is also
supported by other measures of resource utilisation that are not associated with such large
problems in calculation.
Resource utilisation has a positive relationship with future inflation. Resource utilisation is
thus also an indicator of future inflation. It is therefore important to be able to reliably
estimate the level of resource utilisation. But the financial crisis and the associated deep
recession have greatly increased uncertainty in estimates of resource utilisation. Different
assessments of the level of resource utilisation can lead to different views of how monetary
policy ought to be conducted.
It is therefore essential that more analyses are conducted to better understand what it is that
determines the development of output and potential GDP in conjunction with financial crises
and deep recessions. One important factor behind the development of potential GDP seems
to be total factor productivity (TFP). This is particularly troublesome as TFP itself is often
counted as an unexplained residual. One possible way forward could be to combine the
production function approach with economic short-term statistics to analyse how TFP
behaves in normal cyclical fluctuations and in deep recessions. The almost unique
opportunities for Sweden to conduct analyses based on micro data for individuals and
companies should be a major asset in this regard.
Figures and tables
1. Actual and trend GDP
Logarithmed levels
6.5 6.5
GDP
6.0 6.0
Trend
5.5 5.5
5.0 5.0
4.5 4.5
50 55 60 65 70 75 80 85 90 95 00 05 10
Note. HP trend derived solely from annual data 1950-2010.
Sources: Statistics Sweden and the Riksbank
2. Actual and trend growth
Annual percentage change
8 8
GDP growth
6 6
Trend Growth
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
50 55 60 65 70 75 80 85 90 95 00 05 10
Note. HP trend derived solely from annual data 1950-2010.
Sources: Statistics Sweden and the Riksbank
3. Resource utilisation and inflation
Correlation between different measures of resource utilisation
and CPIF inflation, 0-12 quarters ahead
1.0 1.0
GDP gap (PF)
0.8 0.8
Hours gap (PF)
0.6 0.6
RU indicator
0.4 0.4
0.2 0.2
0.0 0.0
-0.2 -0.2
-0.4 -0.4
-0.6 -0.6
0 1 2 3 4 5 6 7 8 9 10 11 12
Note. Estimation period is 1997-2006.
Sources: Statistics Sweden and the Riksbank
4. Total factor productivity
Logarithmed levels
-3.3 -3.3
Actual TFP
-3.4 -3.4
TFP, forecast
Potential TFP
-3.5 -3.5
-3.6 -3.6
-3.7 -3.7
-3.8 -3.8
-3.9 -3.9
80 85 90 95 00 05 10 15 20
Source: The Riksbank
5. Capital stock
Logarithmed level
29.2 29.2
29.0 29.0
28.8 28.8
28.6 28.6
28.4 28.4
28.2 28.2
28.0 28.0
27.8 27.8
80 85 90 95 00 05 10 15 20
Note. Capital services
Sources: The OECD and the Riksbank
6. Number of hours worked
Logarithmed levels
12.2 12.2
Hours
Hours, forecast
Hours, potential
12.2 12.2
Hours, HP trend
12.1 12.1
12.1 12.1
12.0 12.0
12.0 12.0
11.9 11.9
80 85 90 95 00 05 10 15 20
Sources: Statistics Sweden and the Riksbank
7. Actual and potential GDP
Logarithmed levels
14.0 14.0
GDP
GDP, forecast
13.8 13.8
GDP, potential (PF)
GDP, HP-trend
13.6 13.6
13.4 13.4
13.2 13.2
13.0 13.0
12.8 12.8
80 85 90 95 00 05 10 15 20
Sources: Statistics Sweden and the Riksbank
8. GDP gap
Per cent
6 6
GDP gap (HP)
4 4
GDP gap (PF)
2 2
0 0
-2 -2
-4 -4
-6 -6
-8 -8
80 85 90 95 00 05 10
Note. GDP gap (HP) refers to GDP's deviation from trend calculated with a
HPfilter. GDP gap (PF) refers to GDP's deviation from trend calculated with a
production function.
Sources: Statistics Sweden and the Riksbank
9. Hours gap
Per cent
6 6
Hours gap (HP)
4 4
Hours gap
2 2
0 0
-2 -2
-4 -4
-6 -6
80 85 90 95 00 05 10
Note. Hours gap (HP) refers to the deviation of hours worked from trend
calculated with a Hodrick Prescott filter. Hours gap refers to the deviation of hours
worked from the Riksbank's assessed trend for hours worked.
Sources: Statistics Sweden and the Riksbank
10. GDP gap, September and in real time
Per cent
6 6
4 4
September 2011
Real time
2 2
0 0
-2 -2
-4 -4
-6 -6
-8 -8
05 06 07 08 09 10 11 12 13
Note. September 2011 refers to the PF gap. Real time refers to the HP gap
except from October 2010 and onwards when the PF gap is used.
Sources: Statistics Sweden and the Riksbank
11. Capacity utilisation
Per cent, seasonally-adjusted data
100 100
Capacity utilisation in the manufacturing sector
95 95
Mean, 1996-2008
90 90
85 85
80 80
75 75
70 70
95 97 99 01 03 05 07 09 11
Source: Statistics Sweden
12. Employment rate
Percentage of population aged 16-64
85 85
80 80
75 75
Employment rate
70 70
Mean, 2000-2008
65 65
60 60
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
Source: Statistics Sweden
13. RU indicator and GDP gap
Standard deviation and percentage
6 6
GDP gap (PF)
RU indicator
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
-8 -8
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Note. The RU indicator has been normalised so that the mean value is 0 and the
standard deviation is 1. The reference period is 1996-2008. GDP gap according
to production function (PF) approach.
Sources: Statistics Sweden and the Riksbank
14. Actual and long-term unemployment
Per cent of labour force aged 16-64
12 12
10 10
8 8
6 6
4 4
Unemployment
Unemployment, forecast
2 Mean, 2000-2008 2
Long-term unemployment
0 0
80 85 90 95 00 05 10 15 20
Note. Forecast refers to ages 15-74
Sources: Statistics Sweden and the Riksbank
15. Unemployment gap
Per cent
5 5
4 4
3 3
2 2
1 1
0 0
-1 -1
-2 -2
-3 -3
-4 -4
80 85 90 95 00 05 10
Note. Unemployment gap refers to the deviation between actual and long-term
unemployment in Figure 14.
Sources: Statistics Sweden and the Riksbank
16. Labour shortages
Percentage of companies, seasonally-adjusted data
50 50
Labour shortages
45 Mean, 1996-2008 45
40 40
35 35
30 30
25 25
20 20
15 15
10 10
5 5
0 0
96 98 00 02 04 06 08 10
Source: National Institute of Economic Research
17. Beveridge curve
Per cent
0.6
0.5
2008
2011
0.4
2007
2001
rate
2002
0.3
2006
2003
2010
Vacancy 2004
2005
0.2
2009
0.1
0.0
5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5
Unemployment
Note. Years indicate the first quarter of each year.
Sources: Statistics Sweden and the Riksbank
Table 1.
Resource utilisation, second quarter 2011
Gap as percentage and RU indicator in standard deviation
GDP gap, HP 0.4
GDP gap, PF -0.4
Hours gap, HP 0.3
Hours gap, PF -0.8
Capacity utilisation1 -0.3
Employment rate2 0.3
RU indicator 0.2
Unemployment gap3 -1.0
Labour shortage1 2.3
1 Deviation from mean value, percentage points, 1996-2008
2 Deviation from mean value, percentage points, 2000-2008
3 Percentage points, reverse sign