Measuring Potential Output and Output Gap and Macroeconomic Policy: The Case of Kenya

Measuring the level of an economy.s potential output and output gap are essential in identifying a sustainable non-inflationary growth and 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 the 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 over-all trend and performance of the Kenyan economy. This study found that firstly, potential output growth is declining over the recent time and secondly, the Kenyan economy is contracting in the recent years.