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Measuring Potential Output within a State-Space Framework

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  • Maral Kichian

Abstract

In this paper we measure potential output (and consequently the output gap) using state-space models. Given that the estimated output gap is used as an indicator to measure the extent of inflationary pressures in the economy, we evaluate the use of such models for the implementation of monetary policy. Our starting point is the Gerlach and Smets (1997) unobserved-components model, which they applied to the G7 countries. After subjecting this model to various diagnostic tests, we modify certain assumptions in it to reflect specific aspects of the Canadian economy. In particular, we focus on the specification of the permanent component of output and of inflation expectations, the issue of whether to use core or total inflation in the model, and the integration of appropriate supply shocks in the Phillips curve. In each case, the model is subjected to diagnostic tests and is examined for its out-of-sample forecasting performance. With the various modifications, we find that misspecification is somewhat alleviated and out-of-sample forecast performance is improved. Based on this performance, we feel that state-space models of the output gap can be quite useful in the formulation of monetary policy.

Suggested Citation

  • Maral Kichian, 1999. "Measuring Potential Output within a State-Space Framework," Staff Working Papers 99-9, Bank of Canada.
  • Handle: RePEc:bca:bocawp:99-9
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    Cited by:

    1. Arabinda Basistha, 2007. "Trend‐cycle correlation, drift break and the estimation of trend and cycle in Canadian GDP," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 40(2), pages 584-606, May.
    2. Athanasios Orphanides & Simon van Norden, 2002. "The Unreliability of Output-Gap Estimates in Real Time," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 569-583, November.
    3. Andrew Rennison, 2003. "Comparing Alternative Output-Gap Estimators: A Monte Carlo Approach," Staff Working Papers 03-8, Bank of Canada.
    4. Yetman, James, 2003. "Probing potential output: Monetary policy, credibility, and optimal learning under uncertainty," Journal of Macroeconomics, Elsevier, vol. 25(3), pages 311-330, September.
    5. Berger, Tino & Kempa, Bernd, 2014. "Time-varying equilibrium rates in small open economies: Evidence for Canada," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 203-214.
    6. repec:spo:wpecon:info:hdl:2441/7349 is not listed on IDEAS
    7. Gian Luigi Mazzi & Frédéric Reynès & Matthieu Lemoine & Paola Veroni, 2008. "Real Time Estimation of Potential Output and Output Gap for the Euro-Area : Comparing Production Function with Unobserved Components and SVAR Approaches," Working Papers hal-01027422, HAL.
    8. Cayen, Jean-Philippe & van Norden, Simon, 2005. "The reliability of Canadian output-gap estimates," The North American Journal of Economics and Finance, Elsevier, vol. 16(3), pages 373-393, December.
    9. Carlos Hamilton Vasconcelos Araujo & Marta Baltar Moreira Areosa & Osmani Teixera de Carvalho Guillén, 2004. "Estimating Potential Output And The Output Gap For Brazil," Anais do XXXII Encontro Nacional de Economia [Proceedings of the 32nd Brazilian Economics Meeting] 041, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    10. Maral Kichian, 2001. "On the Nature and the Stability of the Canadian Phillips Curve," Staff Working Papers 01-4, Bank of Canada.
    11. Marc-André Gosselin & René Lalonde, 2002. "Une approche éclectique d'estimation du PIB potentiel américain," Staff Working Papers 02-36, Bank of Canada.
    12. Sergey Sinelnikov-Murylev & Sergey Drobyshevsky & Maria Kazakova & Michael Alexeev, 2016. "Decomposition of Russia's GDP Growth Rates," Research Paper Series, Gaidar Institute for Economic Policy, issue 167P, pages 123-123.
    13. Theologos Dergiades & Lefteris Tsoulfidis, 2007. "A New Method For The Estimation Of Capacity Utilization: Theory And Empirical Evidence From 14 Eu Countries," Bulletin of Economic Research, Wiley Blackwell, vol. 59(4), pages 361-381, October.
    14. Jean-Philippe Cayen & Simon van Norden, 2002. "La fiabilité des estimations de l'écart de production au Canada," Staff Working Papers 02-10, Bank of Canada.
    15. Berger, Tino & Kempa, Bernd, 2011. "Bayesian estimation of the output gap for a small open economy: The case of Canada," Economics Letters, Elsevier, vol. 112(1), pages 107-112, July.
    16. Maral Kichian, 2000. "GAUSS™ Programs for the Estimation of State-Space Models with ARCH Errors: A User's Guide," Staff Working Papers 00-2, Bank of Canada.
    17. Pedro Pablo Alvarez Lois, 2000. "Asymmetries In The Capacity-Inflation Trade-Off," UFAE and IAE Working Papers 470.00, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    18. Marc-André Gosselin & René Lalonde, 2006. "An Eclectic Approach to Estimating U.S. Potential GDP," Empirical Economics, Springer, vol. 31(4), pages 951-975, November.

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    More about this item

    Keywords

    Potential output;

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity

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