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A Comparison of Alternative Methodologies for Estimating Potential Output and the Output Gap

Author

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  • Chantal Dupasquier
  • Alain Guay
  • Pierre St-Amant

Abstract

In this paper, the authors survey some of the recent techniques proposed in the literature to measure the trend component of output or potential output. Given the reported shortcomings of mechanical filters and univariate approaches to estimate potential output, the paper focusses on three simple multivariate methodologies: the multivariate Beveridge-Nelson methodology (MBN), Cochrane's methodology (CO), and the structural VAR methodology with long-run restrictions applied to output (LRRO). The foundation of these methodologies is first discussed and then applications to U.S. output and consumption data are considered. The LRRO estimates provide significant evidence of a diffusion process for shocks to potential output. This suggests that permanent shocks have more complex dynamics than a random walk, which is the basic assumption of the CO and MBN approaches. However, it is also found that the estimation of the output gap on the basis of an estimated VAR is imprecise, which is consistent with results obtained by Staiger, Stock and Watson (1996) with a different methodology. The spectra of the transitory components (output gaps) resulting from the empirical applications of the CO, MBN and LRRO methodologies differ from one another. Indeed, only the LRRO transitory component has a peak at business-cycle frequencies, i.e., cycles lasting between 6 and 32 quarters.

Suggested Citation

  • Chantal Dupasquier & Alain Guay & Pierre St-Amant, 1997. "A Comparison of Alternative Methodologies for Estimating Potential Output and the Output Gap," Staff Working Papers 97-5, Bank of Canada.
  • Handle: RePEc:bca:bocawp:97-5
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    References listed on IDEAS

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    Keywords

    Econometric and statistical methods;

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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