Large advanced economies are at a late stage in the business cycle, pointing to limited capacity for growth to exceed estimated supply-side potential growth over the medium-term, according to Fitch Ratings' Economics team.

Fitch has introduced new measures of the output gap - or the degree of economic "slack" - for the 10 advanced economies (DM10) covered in its Global Economic Outlook (GEO). These measures have been built upon the signals sent both by the financial cycle, specifically the role of credit and asset prices, and direct survey-based measures of slack in the labour and product markets.

This hybrid approach contrasts with more traditional approaches to estimating output gaps, which rely heavily on signals sent by inflation and wage developments to gauge the degree of slack. The weakening trade-off between inflation and growth has rendered these estimates less accurate and prone to large-scale subsequent revisions after the event.

The new measures place an equally large weight on measures of the financial cycle and on survey-based estimates of slack in labour and product markets to determine the sustainability of economic growth. The central idea behind the financial cycle component is that excess credit and asset price growth can push economic output a long way from sustainable levels without this necessarily being reflected in movements in inflation. The new output gap estimates appear to generate a more reliable way to infer the state of the business cycle in real time.

For the DM10 overall, our new estimates suggest the GDP-weighted output gap was mildly positive (at around 0.7%) in 2018. This suggests that the scope for advanced economies overall to grow above trend over the medium term is very limited.

On a country level, our analysis points to the largest positive output gaps in 2018 in Japan and Germany. US GDP appears to be a bit higher than its potential level more than a decade after the global financial crisis. The UK, Australia, Italy and Spain were the four DM10 countries that had negative output gaps, suggesting that they still have scope to grow above trend for several years, particularly for Italy.