Is there a Risk of Overheating the Economy?

Overheating the economy is a theoretical concept based on the same idea - potential output. An economy is overheated when actual output exceeds the level of potential output. The idea of ​​potential output refers to the level of output of an economy where resources are maximally utilized under "normal" and "sustainable" conditions. First, such an overheating economy assessment lacks content because it implies producing more than capacity; secondly, the potential output is a non-measurable indicator.

Despite this, central banks, economists, and others still try to estimate the output gap (when the gap is positive, the economy is overheated). For this, the often used data is the real GDP, and the often used model is the Hodrick-Prescott filter. In our case, the assessment made with this approach shows that the GDP gap is expected to be negative in the medium and long term. Thus, the economy is not expected to overheat during this period. The same is true for estimating the economy's overheating using alternative labor market indicators. Such an approach is more logical for estimating the economy overheating than the potential output level. In the nearest period, the actual level of employment fell short of its natural rate, which indicates not the overheating of the economy but, on the contrary, cyclical unemployment. Therefore, discussing the overheating of the economy and such risks lacks theoretical and empirical basis and evidence.

Note: The full document is available only in Georgian.


photo credit: Central Bank of Ireland


Egnate Shamugia