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

  • Chantal Dupasquier
  • Alain Guay
  • Pierre St-Amant

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.

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Paper provided by Bank of Canada in its series Working Papers with number 97-5.

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Length: 27 pages
Date of creation: 1997
Date of revision:
Handle: RePEc:bca:bocawp:97-5
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  24. 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.
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  28. 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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