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A New Technique for Simultaneous Estimation of Potential Output and the Phillips Curve

  • Hirose, Yasuo

    (Bank of Japan)

  • Kamada, Koichiro

    (Bank of Japan)

A new technique is demonstrated for the simultaneous estimation of potential output and the Phillips curve. In this paper, we define potential output as the non-accelerating inflation level of output (NAILO). The NAILO is not a simple trend of actual output. Instead, it is the critical level of output such that, were actual output at this level, the inflation rate would be neither accelerating nor decelerating. Our application is the case of Japan, for which we estimate both the NAILO and the Phillips curve and investigate their properties. It is shown that during the 1980s and 1990s, the Japanese output gap, as measured using the NAILO, was negative on average, reflecting the global trend of disinflation. We also point out that this NAILO-based output gap has displayed a tendency to move in line with corporate sentiment and is thus a useful indicator of business conditions. However, being subject to re-estimation due to the revision of source data and the arrival of new data, the NAILO estimate is surrounded by uncertainty. This uncertainty needs to be kept in mind in real-time analysis, and the NAILO estimate should be interpreted with care, particularly in the process of policymaking.

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Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 21 (2003)
Issue (Month): 2 (August)
Pages: 93-112

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Handle: RePEc:ime:imemes:v:21:y:2003:i:2:p:93-112
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  1. Laurence Ball & N. Gregory Mankiw, 2002. "The NAIRU in Theory and Practice," Harvard Institute of Economic Research Working Papers 1963, Harvard - Institute of Economic Research.
  2. Harvey, A C & Jaeger, A, 1993. "Detrending, Stylized Facts and the Business Cycle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 8(3), pages 231-47, July-Sept.
  3. Robert J. Gordon, 1996. "The Time-Varying NAIRU and its Implications for Economic Policy," NBER Working Papers 5735, National Bureau of Economic Research, Inc.
  4. Higo, Masahiro & Nakada, Sachiko-Kuroda, 1998. "How Can We Extract a Fundamental Trend from an Economic Time- Series?," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 16(2), pages 61-111, December.
  5. Koichiro Kamada & Kazuto Masuda, 2000. "Effects of Measurement Error on the Output Gap in Japan," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
  6. James G. MacKinnon, 2002. "Bootstrap inference in econometrics," Canadian Journal of Economics, Canadian Economics Association, vol. 35(4), pages 615-645, November.
  7. Athanasios Orphanides, 1998. "Monetary policy rules based on real-time data," Finance and Economics Discussion Series 1998-03, Board of Governors of the Federal Reserve System (U.S.).
  8. Robert J. Gordon, 1998. "Foundations of the Goldilocks Economy: Supply Shocks and the Time-Varying NAIRU," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 297-346.
  9. Yasuo Hirose & Koichiro Kamada, 2002. "Time-Varying NAIRU and Potential Growth in Japan," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
  10. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
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