Measuring an economy’s cyclical position

Since 2015, the public finances in Ireland have been subject to the preventive arm of the Stability and Growth Pact (SGP). A key requirement of the preventive arm is that Member States meet or progress towards their Medium Term Budgetary Objective (MTO). As the MTO is set in cyclically adjusted terms, an estimate of the economic cycle – the output gap – is needed. However, estimating an economy’s potential output and the output gap is not an easy task as neither is directly observable.