Do financial crises erode potential output? A cross-country analysis of industrial and emerging economies

Abstract

Purpose The purpose of this paper is to analyze empirically if financial crises have decreased potential output for a selected group of economies. Design/methodology/approach The authors estimate different country-specific stylized Phillips curves to verify if inflationary pressures were stronger on the recovery periods after financial crises, relative to the recovery periods after recessions. Findings The results, in general, do not show any clear empirical evidence that financial crises erode potential output. Moreover, there are no apparent differences in terms of the effects of financial crises over potential output between emerging and industrial economies. Research limitations/implications This paper sheds light on the widely debated issue of whether financial crises constitute adverse supply shocks that lead to impairment in an economy’s productive potential. In interpreting the results, the authors must first recognize that all of them are based on the reduced-form relationships. Thus, they are about correlations and not necessarily about true structural relationships. Practical implications The study is very important for policy makers and specially Central Banks worldwide. Social implications The loss of potential output is a very serious economic and social phenomenon. This paper sheds light on the debate if financial crisis lead to losses of potential output. Originality/value The paper is original in using more Phillips curves and because it studies also the behavior of emerging economies.