The interplay of supply and demand shocks: measuring potential output in the COVID-19 pandemic

Abstract

The coronavirus triggered a record fall of GDP in Croatia, 8.1% in 2020, one of the largest declines in the EU. The large macroeconomic shock stemming from the pandemic has affected both supply and demand. On the one hand, government measures have imposed unprecedented supply-side restrictions. On the other hand, growing uncertainty affected domestic and foreign demand. Croatia was particularly affected by a plunge in international tourism demand. Such a major macroeconomic shock poses a challenge for estimating potential GDP, which is difficult to estimate even in stable economic conditions. When estimating potential GDP in the context of the corona crisis, the main issue is the breakdown of the shock into a permanent and a temporary part (supply and demand shock). In this paper, we try to give the most logical breakdown of Croatian data and describe possible methodological approaches to the estimation of potential GDP during the pandemic. © 2021. All Rights Reserved.