The effect of financial crises on potential output: New empirical evidence from OECD countries

Abstract

The aim of this paper is to assess the impact of financial crises on potential output. For this purpose a univariate autoregressive growth equation is estimated on an unbalanced panel of OECD countries over the period 1960–2008. Our results suggest that the occurrence of a financial crisis negatively and permanently affects potential output. In particular, financial crises are estimated to lower potential output by around 1.5–2.4% on average, with most of the impact coming from the effect on capital. The magnitude of the effect increases with the severity of the crisis. These results are robust to the use of an alternative measure of potential output, changes in the methodology and in the sample periods. The impact of financial crises is also found to vary according to structural features of the economies, such as the degree of openness, macro-economic imbalances, financial deepening and the qual-ity of governance.