Discussion Paper No.28 of 2003 on Alternative Methodologies for Measuring Kenya's Potential Output and Output Gap

Abstract

Measuring thelevelof an economy's potential output and output gap is essential in identifying a sustainable non-inflationary growth and in assessing appropriate macroeconomic policies. The estimation of potential output helps to determine the pace of sustainable growth, while output gap estimates provide a key benchmark against which to assess inflationary or disinflationary pressures, suggesting when to tighten or ease monetary policies. These measures also help to provide a gauge in determining the structural fiscal position of the government. This paper attempts to measure Kenya's potential output and output gap using alternative statistical techniques and structural methods. Estimation of potential output and output gap using these techniques shows varied results. The estimated potential output growth using different methods gave a range of -2.9 to 2.4 percent for 2000 and a range of -0.8 to 4.6 for 2001. Although various methods produce varied results, they however provided a broad consensus on the overall trend and performance of Kenya's economy. This studyfound that firstly, potential output growth has been declining over the recent time and secondly, Kenya's economy has contracted in the recent years.