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Why Is It So Hard to Measure the Current Output Gap?

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  • Simon van Norden

    ((Bank of Canada))

Abstract

In order for time series estimates of the output gap to be useful to policy makers, this paper argues that two factors will be critical. First, they must be able to produce an estimate of the current output gap based only on past information. Put another way, to evaluate the performance of such estimators, we should focus on their properties as _filters_ rather than _smoothers_. Second, the decomposition of actual output into potential output and the output gap must not be based on arbitrary assumptions about the time-series behaviour of these variables. In general, this leads to a multiplicity of possible solutions that may differ greatly in their policy implications. The arbitrary selection of one of these creates arbitrary policy advice. A trivial but flexible estimator of the output gap (dubbed TOFU) can be constructed which satisfies both of the above criteria. It estimates the output gap as part of a larger economic relationship. A discussion of its properties shows that except under very strict circumstances, such time series estimates will produce better estimates of the output gap ex post than they will ex ante. Furthermore, under certain conditions, contemporary and historical data will be of no use in estimating the output gap whatsoever. This in turn places limits on the extent to which time series methods can hope to improve upon structural estimates of the output gap.

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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 9506001.

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Length: 22 pages
Date of creation: 07 Jun 1995
Date of revision:
Handle: RePEc:wpa:wuwpma:9506001

Note: 22 pages of text & 3 pages graphs. Text and Graphs in separate Postscript files. Files compressed in a single Info-zip archive, then uuencoded.
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References

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  1. Marco Lippi & Lucrezia Reichlin, 1993. "The dynamic effects of aggregate demand and supply disturbances: comment," ULB Institutional Repository 2013/10159, ULB -- Universite Libre de Bruxelles.
  2. George Evans & Lucrezia Reichlin, 1994. "Information, forecasts and measurement of the business cycle," ULB Institutional Repository 2013/10155, ULB -- Universite Libre de Bruxelles.
  3. Setterfield, M. A. & Gordon, D. V. & Osberg, L., 1992. "Searching for a will o' the wisp : An empirical study of the NAIRU in Canada," European Economic Review, Elsevier, vol. 36(1), pages 119-136, January.
  4. Lippi, Marco & Reichlin, Lucrezia, 1994. "VAR analysis, nonfundamental representations, blaschke matrices," Journal of Econometrics, Elsevier, vol. 63(1), pages 307-325, July.
  5. Alain DeSerres, & Alain Guay & Pierre St-Amant, . "Estimating and Projecting Potential Output Using Structural VAR Methodology: The Case of the Mexican Economy," Working Papers 95-2, Bank of Canada.
  6. Claude Giorno & Pete Richardson & Deborah Roseveare & Paul van den Noord, 1995. "Estimating Potential Output, Output Gaps and Structural Budget Balances," OECD Economics Department Working Papers 152, OECD Publishing.
  7. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  8. Christopher A. Sims, 1986. "Are forecasting models usable for policy analysis?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-16.
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Citations

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Cited by:
  1. Alain Guay & Pierre St-Amant, 1997. "Do the Hodrick-Prescott and Baxter-King Filters Provide a Good Approximation of Business Cycles?," Cahiers de recherche CREFE / CREFE Working Papers 53, CREFE, Université du Québec à Montréal.
  2. Martha Misas Arango & Enrique López, 2000. "La Utilización De La Capacidad Instalada De La Industria En Colombia: Un Nuevo Enfoque," BORRADORES DE ECONOMIA 003096, BANCO DE LA REPÚBLICA.
  3. Guay, A & St-Amant, P, 1996. "Do Mechanical Filters Provide a Good Approximation of Business Cycles?," Technical Reports 78, Bank of Canada.
  4. Chantal Dupasquier & Alain Guay & Pierre St-Amant, 1997. "A Comparison of Alternative Methodologies for Estimating Potential Output and the Output Gap," Working Papers 97-5, Bank of Canada.
  5. Tatiana Cesaroni, 2010. "Estimating potential output using business survey data in a svar framework," Economics Bulletin, AccessEcon, vol. 30(3), pages 2249-2258.
  6. Liu, Fei, 2011. "中国产出缺口的估计(1985-2009)及两种评估方法的比较
    [China's output gap estimates (1985-2009) and comparison of the two estimation methods]
    ," MPRA Paper 38785, University Library of Munich, Germany.
  7. Gonzalo Llosa & Shirley Miller, 2005. "Using additional information in estimating the output gap in Peru: a multivariate unobserved component approach," Working Papers 2005-004, Banco Central de Reserva del Perú.
  8. Razzak, W., 1997. "The Hodrick-Prescott technique: A smoother versus a filter: An application to New Zealand GDP," Economics Letters, Elsevier, vol. 57(2), pages 163-168, December.
  9. Onur Ince & David H. Papell, 2013. "The (Un)Reliability of Real-Time Output Gap Estimates with Revised Data," Working Papers 13-02, Department of Economics, Appalachian State University.
  10. Adriana Z. Fernandez & Evan F. Koenig & Alex Nikolsko-Rzhevskyy, 2008. "The relative performance of alternative Taylor rule specifications," Staff Papers, Federal Reserve Bank of Dallas, issue Jun.
  11. Fernandez, Adriana Z. & Koenig, Evan F. & Nikolsko-Rzhevskyy, Alex, 2010. "Can alternative Taylor-rule specifications describe Federal Reserve policy decisions?," Journal of Policy Modeling, Elsevier, vol. 32(6), pages 733-757, November.
  12. Dupasquier, Chantal & Guay, Alain & St-Amant, Pierre, 1999. "A Survey of Alternative Methodologies for Estimating Potential Output and the Output Gap," Journal of Macroeconomics, Elsevier, vol. 21(3), pages 577-595, July.
  13. Gonzalo Llosa/Shirley Miller, 2004. "Using additional information in estimating output gap in Peru: a multivariate unobserved component approach," Econometric Society 2004 Latin American Meetings 243, Econometric Society.
  14. Nikolsko-Rzhevskyy, Alex, 2008. "Monetary Policy Evaluation in Real Time: Forward-Looking Taylor Rules Without Forward-Looking Data," MPRA Paper 11352, University Library of Munich, Germany.
  15. 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.

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