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Output gap and inflation nexus: the case of United Arab Emirates

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  • Osman, Mohammad
  • Jean Louis, Rosmy
  • Balli, Faruk

Abstract

Output gap is generally used in assessing both the inflationary pressures and the cyclical position of a nation’s economy. However, this variable is not observable and must be estimated. In this paper, we accomplish two tasks. First, we estimate the output gap for the United Arab Emirates (UAE) using four different statistical methods (i.e. the linear method, the Hodrick-Prescott filter, Band-pass filter and the unobserved components model). Second, we evaluate to what extent the fluctuations of output gap, however constructed or measured, are a good predictor of inflation in the UAE. This is carried out by comparing the out-of-sample forecasts generated by the output gap based models to those of the model with alternative indicator, and the benchmark models. Interestingly, although the different measures of output gap produce a broadly similar profile of the UAE business cycles, we could not find any statistical evidence that this variable is a useful predictor of inflation in the UAE.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34006.

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Date of creation: 2008
Date of revision: 2009
Publication status: Published in International Journal of Economics and Business Research 1.1(2009): pp. 118-135
Handle: RePEc:pra:mprapa:34006

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Keywords: Output Gap; Inflation; Forecast; Forecast Accuracy; Forecast Encompassing;

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  1. Prakash Loungani & Phillip Swagel, 2001. "Sources of Inflation in Developing Countries," IMF Working Papers 01/198, International Monetary Fund.
  2. Angel J. Ubide & Kevin Ross, 2001. "Mind the Gap," IMF Working Papers 01/203, International Monetary Fund.
  3. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Athanasios Orphanides & Simon van Norden, 2003. "The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time," CIRANO Working Papers 2003s-01, CIRANO.
  5. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  7. Lei Lei Song, 2005. "Do underlying measures of inflation outperform headline rates? Evidence from Australian data," Applied Economics, Taylor & Francis Journals, vol. 37(3), pages 339-345.
  8. Iris Claus, 2000. "Is the output gap a useful indicator of inflation?," Reserve Bank of New Zealand Discussion Paper Series DP2000/05, Reserve Bank of New Zealand.
  9. El-Sakka M. I. T. & Ghali Khalifa H, 2005. "The Sources of Inflation in Egypt: A Multivariate Co-integration Analysis," Review of Middle East Economics and Finance, De Gruyter, vol. 3(3), pages 84-96, December.
  10. Michael Graff, 2004. "Estimates of the output gap in real time: how well have we been doing?," Reserve Bank of New Zealand Discussion Paper Series DP 2004/04, Reserve Bank of New Zealand.
  11. St-Amant, P. & van Norden, S., 1997. "Measurement of the Output Gap: A Discussion of Recent Research at the Bank of Canada," Technical Reports 79, Bank of Canada.
  12. Harvey, David & Leybourne, Stephen & Newbold, Paul, 1997. "Testing the equality of prediction mean squared errors," International Journal of Forecasting, Elsevier, vol. 13(2), pages 281-291, June.
  13. Watson, Mark W., 1986. "Univariate detrending methods with stochastic trends," Journal of Monetary Economics, Elsevier, vol. 18(1), pages 49-75, July.
  14. Clark, Peter K., 1989. "Trend reversion in real output and unemployment," Journal of Econometrics, Elsevier, vol. 40(1), pages 15-32, January.
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