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Dismiss the output gaps? To use with caution given their limitations

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  • Pichette, Lise
  • Robitaille, Marie-Noëlle
  • Salameh, Mohanad
  • St-Amant, Pierre

Abstract

The link between inflation and the output gap is central to the conduct of monetary policy. In this paper, we use a new real-time database for Canada to study various output gap measures. We analyze output gap revisions and assess the usefulness of these gaps in forecasting total CPI inflation and three newly developed measures of core CPI inflation: CPI-median, CPI-trim and CPI-common. We also consider labour input gaps, projected output gaps, and simple combinations of output gaps. We find that, when forecasting CPI-common and CPI-trim, some gaps appear to provide information that reduces forecast errors when compared with models that use only lags of inflation. However, forecast improvements are rarely statistically significant. In addition, we find little evidence of the usefulness of output gaps in forecasting inflation measured by total CPI and CPI-median. These results call for cautiousness when central banks use output gaps to forecast inflation as their usefulness is limited.

Suggested Citation

  • Pichette, Lise & Robitaille, Marie-Noëlle & Salameh, Mohanad & St-Amant, Pierre, 2019. "Dismiss the output gaps? To use with caution given their limitations," Economic Modelling, Elsevier, vol. 76(C), pages 199-215.
    • Handle: RePEc:eee:ecmode:v:76:y:2019:i:c:p:199-215
    DOI: 10.1016/j.econmod.2018.08.001
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    Cited by:

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    2. Augustus J. Panton, 2020. "Climate hysteresis and monetary policy," CAMA Working Papers 2020-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    3. Camila Figueroa & Jorge Fornero & Pablo García, 2019. "Hindsight vs. Real time measurement of the output gap: Implications for the Phillips curve in the Chilean Case," Working Papers Central Bank of Chile 854, Central Bank of Chile.
    4. Calista Cheung & Luke Frymire & Lise Pichette, 2020. "Can the Business Outlook Survey Help Improve Estimates of the Canadian Output Gap?," Discussion Papers 2020-14, Bank of Canada.
    5. Lise Pichette & Maria Bernier & Marie-Noëlle Robitaille, 2018. "An Alternative Estimate of Canadian Potential Output: The Multivariate State-Space Framework," Discussion Papers 18-14, Bank of Canada.

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