Errors in the measurement of the output gap and the design of monetary policy

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Errors in the measurement of the output gap and the design of monetary policy

Author Info

Athanasios Orphanides
Richard D. Porter
David Reifschneider
Robert Tetlow
Frederico Finan

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Abstract

We exploit data on historical revisions to real-time estimates of the output gap to examine the implications of measurement error for the design of monetary policy, using the Federal Reserve's model of the U.S. economy, FRB/US. Measurement error brings about a substantial deterioration in economic performance, although the problem can be mitigated somewhat by reducing the coefficient on the output gap in policy rules. We also show that it is usually optimal to place some weight on the level of the output gap in the conduct of policy, but under extreme conditions it may be preferable to focus on output growth.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 1999-45.

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Date of creation: 1999
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Handle: RePEc:fip:fedgfe:1999-45

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Article
- Orphanides, Athanasios & Porter, Richard D. & Reifschneider, David & Tetlow, Robert & Finan, Frederico, 2000. "Errors in the measurement of the output gap and the design of monetary policy," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 117-141. [Downloadable!] (restricted)

This paper has been announced in the following NEP Reports:

NEP-ALL-1999-10-20 (All new papers)

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