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Output Gap in Colombia: An Eclectic Approach

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  • Adolfo L.Cobo

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    Abstract

    In an economy conducted under an Inflation Targeting regime, the output gap becomes one of the most important variables to guide monetary policy. Defined as the difference between observed and potential or non-inflationary output, the gap is a measure of the state of aggregate demand and, therefore, of inflationary pressures on the economy. However, this relationship might be obscured by supply and price shocks, perhaps more relevant in the case of emerging economies. This paper estimates and evaluates the output gap for Colombia between 1970 and 2003 using a wide array of methods that go from univariate approaches such as Hodrick-Prescott (HP) and Band Pass filters to multivariate or structural methods obtained by the Kalman filter technique or the production function approach. We also include some mixed procedures like the multivariate filter and the prior-consistent filter. The last one takes into account some supply and price shocks observed in the Colombian economy since 1990. An evaluation of the different estimators is made by a simulated out-of sample forecasting exercise. The results show that multivariate structural filters have a better performance than pure mechanical approaches, but the difference is marginal with respect to a prior-consistent HP filter that takes into account supply shocks. In general, the forecasting performance of all the output gaps estimators improves when we re-define core inflation to exclude some price shocks.

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    Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 327.

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    Handle: RePEc:bdr:borrec:327

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    Keywords: Colombia; output gap; inflation forecasting; supply shocks.;

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    1. Odile Chagny & Jörg Döpke, 2001. "Measures of the Output Gap in the Euro-Zone: An Empirical Assessment of Selected Methods," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, DIW Berlin, German Institute for Economic Research, vol. 70(3), pages 310-332.
    2. Paul Conway & Ben Hunt, 1997. "Estimating potential output: a semi-structural approach," Reserve Bank of New Zealand Discussion Paper Series G97/9, Reserve Bank of New Zealand.
    3. Robert J. Gordon, 1997. "The Time-Varying NAIRU and Its Implications for Economic Policy," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 11(1), pages 11-32, Winter.
    4. Sweta Chaman Saxena & Valerie Cerra, 2000. "Alternative Methods of Estimating Potential Output and the Output Gap," IMF Working Papers, International Monetary Fund 00/59, International Monetary Fund.
    5. Andrew Rennison, 2003. "Comparing Alternative Output-Gap Estimators: A Monte Carlo Approach," Working Papers, Bank of Canada 03-8, Bank of Canada.
    6. Hamid Faruqee & Douglas Laxton & Bart Turtelboom & Peter Isard & Eswar Prasad, 1998. "Multimod Mark III," IMF Occasional Papers, International Monetary Fund 164, International Monetary Fund.
    7. Gerlach, Stefan & Yiu, Matthew S., 2004. "Estimating output gaps in Asia: A cross-country study," Journal of the Japanese and International Economies, Elsevier, vol. 18(1), pages 115-136, March.
    8. Juan Manuel Julio, 2001. "How Uncertain are NAIRU Estimates in Colombia?," BORRADORES DE ECONOMIA, BANCO DE LA REPÚBLICA 002798, BANCO DE LA REPÚBLICA.
    9. Andreas Billmeier, 2004. "Ghostbusting," IMF Working Papers, International Monetary Fund 04/146, International Monetary Fund.
    10. Odile Chagny & Jörg Döpke, 2001. "Measures of the Output Gap in the Euro-Zone: An Empirical Assessment of Selected Methods," Kiel Working Papers, Kiel Institute for the World Economy 1053, Kiel Institute for the World Economy.
    11. Jaromir Benes & Papa M'B. P. N'Diaye, 2004. "A Multivariate Filter for Measuring Potential Output and the NAIRU Application to the Czech Republic," IMF Working Papers, International Monetary Fund 04/45, International Monetary Fund.
    12. Jorge Iván RODRIGUEZ MUÑOZ & Juan Ricardo PERILLA JIMENEZ & José Daniel REYES PEÑA, 2004. "Cálculo del PIB Potencial en Colombia.:1970-2003," ARCHIVOS DE ECONOMÍA, DEPARTAMENTO NACIONAL DE PLANEACIÓN 002078, DEPARTAMENTO NACIONAL DE PLANEACIÓN.
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