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Measuring Potential Output within a State-Space Framework


  • Kichian, Maral


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

  • Kichian, Maral, 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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    References listed on IDEAS

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    16. Dupasquier, Chantal & Ricketts, Nicholas, 1998. "Non-Linearities in the Output-Inflation Relationship: Some Empirical Results for Canada," Staff Working Papers 98-14, Bank of Canada.
    17. Nicholas Ricketts & David Rose, "undated". "Inflation, Learning And Monetary Policy Regimes In The G-7 Economies," Staff Working Papers 95-6, Bank of Canada.
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    Cited by:

    1. 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.
    2. Yetman, James, 2003. "Probing potential output: Monetary policy, credibility, and optimal learning under uncertainty," Journal of Macroeconomics, Elsevier, pages 311-330.
    3. Berger, Tino & Kempa, Bernd, 2014. "Time-varying equilibrium rates in small open economies: Evidence for Canada," Journal of Macroeconomics, Elsevier, pages 203-214.
    4. 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," Sciences Po publications 2008-34, Sciences Po.
    5. Berger, Tino & Kempa, Bernd, 2014. "Time-varying equilibrium rates in small open economies: Evidence for Canada," Journal of Macroeconomics, Elsevier, pages 203-214.
    6. Athanasios Orphanides & Simon van Norden, 2002. "The Unreliability of Output-Gap Estimates in Real Time," The Review of Economics and Statistics, MIT Press, pages 569-583.
    7. Marc-André Gosselin & René Lalonde, 2006. "An Eclectic Approach to Estimating U.S. Potential GDP," Empirical Economics, Springer, pages 951-975.
    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 32th Brazilian Economics Meeting] 041, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
    10. 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.
    11. Maral Kichian, 2001. "On the Nature and the Stability of the Canadian Phillips Curve," Staff Working Papers 01-4, Bank of Canada.
    12. Kichian, Maral, 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.
    13. 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).
    14. Marc-André Gosselin & René Lalonde, 2002. "Une approche éclectique d'estimation du PIB potentiel américain," Staff Working Papers 02-36, Bank of Canada.
    15. repec:spo:wpecon:info:hdl:2441/7349 is not listed on IDEAS
    16. Yetman, James, 2003. "Probing potential output: Monetary policy, credibility, and optimal learning under uncertainty," Journal of Macroeconomics, Elsevier, pages 311-330.
    17. 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, pages 123-123.
    18. Andrew Rennison, 2003. "Comparing Alternative Output-Gap Estimators: A Monte Carlo Approach," Staff Working Papers 03-8, Bank of Canada.

    More about this item


    Potential output;

    JEL classification:

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


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