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The Usefulness of Output Gaps for Policy Analysis

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  • Isabell Koske
  • Nigel Pain

Abstract

Measures of the gap between actual and potential activity are used frequently as indicators of the economic cycle and play a vital role in the conduct of monetary and fiscal policy. Given that output and unemployment gap estimates are often subject to considerable revision over time, this paper investigates the uncertainty surrounding projections and early outturn estimates of such gaps and evaluates their usefulness for policy making in real time. Current-year projections and initial outturn estimates of the gaps both appear to provide a reasonably good picture of the business cycle over the period studied, but one-year-ahead projections perform rather poorly. Projections made at cyclical turning points are subject to greater revision than those made at other times. Revisions to output gaps appear to stem primarily from revisions to actual rather than potential GDP. Empirical results show that output gaps remain a significant influence on inflation, but their influence is now weaker than in the past, and the usefulness of output gap estimates for real-time inflation projections is limited. Revisions to real-time output gaps also generate revisions to real-time estimates of the fiscal stance, although typically these are relatively moderate. Despite the uncertainty attached to gap estimates, they remain useful for policymakers, helping to situate current economic developments. L'utilité de l'écart de production pour l'analyse de politique macroéconomique Les estimations de l’écart entre l’activité courante et potentielle sont fréquemment utilisées comme indicateurs du cycle économique et jouent un rôle crucial dans la conduite des politiques monétaire et budgétaire. Étant donné, qu’au fil du temps les estimations des écarts de croissance et de chômage sont souvent révisées, ce papier évalue l’incertitude qui entoure les prévisions ainsi que les premières estimations de ces écarts pour l’année écoulée et analyse leur utilité pour les décisions de politique économique en temps réel. Les prévisions pour l’année en cours et les premières estimations pour l’année écoulée des écarts donnent une image assez représentative du cycle sur la période étudiée tandis que les prévisions à un an sont plutôt médiocres. Les prévisions qui sont faites lors d’un retournement de cycle sont sujettes á de plus fortes révisions que celles réalisées á d’autres périodes. Les révisions des écarts de production viennent d’abord des révisions du PIB courant plutôt que du potentiel. Les résultats empiriques montrent que les écarts de production continuent d’influer sur l’inflation même si leur effet est moindre que par le passé et que ’ utilité des estimations des écarts de production pour les prévisions de l’inflation en cours est limitée. Les révisions des écarts de production courants génèrent aussi des révisions des estimations de la situation fiscale courante, même si ceux-ci sont relativement modérés. Malgré l’incertitude liée aux estimations des écarts de croissance, ces dernières demeurent utiles pour les décideurs politiques dans la mesure où elles les aident à évaluer la situation économique courante.

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Bibliographic Info

Paper provided by OECD Publishing in its series OECD Economics Department Working Papers with number 621.

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Date of creation: Jul 2008
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Handle: RePEc:oec:ecoaaa:621-en

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Keywords: Uncertainty; output gap; cyclically-adjusted budget balance; inflation forecasting; solde budgétaire ajusté du cycle; incertitude; prévision d’inflation; écart de production;

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Citations

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Cited by:
  1. Hjelm, Göran & Jönsson, Kristian, 2010. "In Search of a Method for Measuring the Output Gap of the Swedish Economy," Working Paper 115, National Institute of Economic Research.
  2. Antonio Bassanetti & Michele Caivano & Alberto Locarno, 2013. "Modelling italian potential output and the output gap," Working Papers 7, Department of the Treasury, Ministry of the Economy and of Finance.
  3. Tony McDonald & Yong Hong Yan & Blake Ford & David Stephan, 2010. "Estimating the structural budget balance of the Australian Government," Economic Roundup, Treasury, Australian Government, issue 3, pages 51-79, October.
  4. Berger, Tino & Kempa, Bernd, 2014. "Time-varying equilibrium rates in small open economies: Evidence for Canada," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 203-214.
  5. Baum, Anja & Koester, Gerrit B., 2011. "The impact of fiscal policy on economic activity over the business cycle - evidence from a threshold VAR analysis," Discussion Paper Series 1: Economic Studies 2011,03, Deutsche Bundesbank, Research Centre.
  6. Łukasz Rawdanowicz, 2012. "Choosing the Pace of Fiscal Consolidation," OECD Economics Department Working Papers 992, OECD Publishing.

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