Public Finance and Role of Structural Determinants of Potential Output Growth in Emerging Asia

Abstract

Potential output is significant in anticipating the longer-term direction of the economy. Its relevance in predicting arises from the fact that, over the longer term, actual output tends to move in line with potential output. Potential output is the maximum GDP that the economy can attain upon proper utilization of its resources. The recent advent of economic crises in multiple countries around the world also brought to attention the effects they have on potential output. A crisis can reduce potential output in the short and medium-term through its adverse impact on the economy. We used the Panel Fully Modified Least Squares (FMOLS) methodology to assess the impact of several structural determinants on potential production growth in Asia's emerging economies from the period 1997 to 2019. We also examine the effect of public finance in determining whether fiscal rules caused to the decline of potential growth, particularly following the financial and sovereign debt crises. The concept of potential output is also essential to government operations. An evaluation of the degree of excess demand or excess supply will have its impact on the fiscal policy. According to estimated results, research and development, population, tertiary education, trade openness, and institutional efficiency, and all these factors played a major role in potential output growth over the time span under consideration. Whereas financial integration has negative impact on the potential output.  It has also found that debt accumulation has a positive impact on potential output. The two key objectives of fiscal policy are employment and price stability and, both are linked to potential output directly or indirectly. As a result, potential output is essential for understanding and implementing fiscal policy.