Output gaps and monetary policy at low interest rates
Policymakers use various indicators of economic activity to assess economic conditions and set an appropriate stance for monetary policy. A key challenge for policymakers is finding indicators that give a clear and accurate signal of the state of the economy in real time—that is, at the time policy is actually made. Unfortunately, most indicators are initially estimated based on incomplete information and subsequently revised as more information becomes available. Moreover, some indicators are based on economic concepts that are not directly observable. ; Two indicators of economic activity often used to guide monetary policy are the output gap and the growth rate of real GDP. The output gap measures how far the economy is from its full employment or “potential” level. The output gap is a noisy signal of economic activity, however, because it depends on potential GDP, which is unobservable, and because it depends on estimates of GDP that are subject to revision. In contrast, estimates of GDP growth have the advantage of being observable—albeit with a lag. But these estimates are also subject to revision as more and better underlying information becomes available. Given the possibility that either of the indicators could give an inaccurate signal in real time, should one indicator be favored over the other as a guide for policy? ; Billi uses a standard model to compare economic performance under a policy that focuses on the output gap with one that focuses on GDP growth. He concludes that policymakers should usually focus on the output gap as an indicator of economic activity when policy rates are constrained by the ZLB. A policy that focuses on GDP growth can lead to more frequent encounters with the ZLB, which, in turn, lead to more volatility in output and inflation. In failing to account for the ZLB, previous research overstated the effectiveness of a policy that focuses on GDP growth.
Volume (Year): (2011)
Issue (Month): Q I ()
|Contact details of provider:|| Postal: One Memorial Drive, Kansas City, MO 64198|
Phone: (816) 881-2254
Web page: http://www.kansascityfed.org
More information through EDIRC
|Order Information:|| Email: |
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Kiley, Michael T., 2013. "Output gaps," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 1-18.
- Glenn D. Rudebusch, 2002.
"Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty,"
Royal Economic Society, vol. 112(479), pages 402-432, April.
- Glenn Rudebusch, 2000. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Econometric Society World Congress 2000 Contributed Papers 0065, Econometric Society.
- Glenn D. Rudebusch, 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 2000-03, Federal Reserve Bank of San Francisco.
- Rudebusch, Glenn D., 2000. "Assessing nominal income rules for monetary policy with model and data uncertainty," Working Paper Series 0014, European Central Bank.
- Aoki, Kosuke, 2003. "On the optimal monetary policy response to noisy indicators," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 501-523, April.
- Roberto M. Billi, 2009. "Was monetary policy optimal during past deflation scares?," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 67-98.
- Justin Weidner & John C. Williams, 2009. "How big is the output gap?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jun12. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:fip:fedker:y:2011:i:qi:n:v.96no.1. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (LDayrit)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.