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A parsimonious approach to incorporating economic information in measures of potential output

Author

Listed:
  • Claudio Borio
  • Piti Disyatat
  • Mikael Juselius

Abstract

A popular strategy for estimating output gaps is to anchor them to structural economic relationships. The resulting output gaps, however, are often highly sensitive to numerous auxiliary assumptions inherent in the approach. This complicates their use in policymaking. We illustrate the point using the Phillips curve, arguably the most popular structural relationship in this context. Depending on the specification, we show that conditioning on this relationship either introduces a trend in the output gap - which is conceptually unappealing - or has little effect on it - which defeats the purpose of the exercise. Moreover, the estimated gaps perform poorly in real time, with large ex-post revisions. The opaqueness of the approach, which increases greatly with the dimension of the estimated system, can mask these problems. In order to address these limitations, we propose a more parsimonious and transparent approach to embedding economic information that is less vulnerable to misspecification. As an illustration, we apply the corresponding parsimonious multivariate filter to US data. We find that proxies for the financial cycle, notably credit growth, but also unemployment contain significant information and help generate robust real-time output gap estimates.

Suggested Citation

  • Claudio Borio & Piti Disyatat & Mikael Juselius, 2014. "A parsimonious approach to incorporating economic information in measures of potential output," BIS Working Papers 442, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:442
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Jérôme Creel & Maurizio Iacopetta, 2015. "Macroeconomic Policy and potential growth," Documents de Travail de l'OFCE 2015-15, Observatoire Francais des Conjonctures Economiques (OFCE).
    2. Pau Rabanal & Marzie Sanjani, 2015. "Incorporating Financial Cycles in Output Gap Measures: Estimates for the Euro Area," 2015 Meeting Papers 426, Society for Economic Dynamics.
    3. Melolinna, Marko & Tóth, Máté, 2016. "Output gaps, inflation and financial cycles in the United Kingdom," Bank of England working papers 585, Bank of England.
    4. Grintzalis, Ioannis & Lodge, David & Manu, Ana-Simona, 2017. "The implications of global and domestic credit cycles for emerging market economies: measures of finance-adjusted output gaps," Working Paper Series 2034, European Central Bank.
    5. repec:bla:sajeco:v:85:y:2017:i:2:p:161-177 is not listed on IDEAS
    6. Fethi Ogunc & Cagri Sarikaya, 2015. "Enflasyonu Aciklamada Kredilerin Bilgi Degeri," CBT Research Notes in Economics 1512, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
    7. Ashwin Madhou, 2015. "Demystifying output gap pressure through surveys in a monetary analysis setting: an experimental perspective," IFC Bulletins chapters,in: Bank for International Settlements (ed.), Indicators to support monetary and financial stability analysis: data sources and statistical methodologies, volume 39 Bank for International Settlements.
    8. Mariarosaria Comunale & Jeroen Hessel, 2014. "Current account imbalances in the Euro area: Competitiveness or financial cycle?," DNB Working Papers 443, Netherlands Central Bank, Research Department.
    9. Enrique Alberola-Ila & Rocío Gondo & Marco Jacopo Lombardi & Diego Urbina, 2016. "Output gaps and policy stabilisation in Latin America: the effect of commodity and capital flow cycles," BIS Working Papers 568, Bank for International Settlements.
    10. R. Barrell & D. Karim & Corrado Macchiarelli, 2017. "Towards an understanding of credit cycles: do all credit booms cause crises?," Working Paper series 17-28, Rimini Centre for Economic Analysis.
    11. Pau Rabanal & Marzie Taheri Sanjani, 2015. "Financial Factors; Implications for Output Gaps," IMF Working Papers 15/153, International Monetary Fund.
    12. Vashchelyuk, N.V. & Zubarev, Andrey & Trunin, Pavel, 2016. "Determination of the Output Gap for the Russian Economy," Working Papers 2137, Russian Presidential Academy of National Economy and Public Administration.
    13. Schleer, Frauke & Kappler, Marcus, 2014. "The Phillips Curve: (In)stability, the role of credit, and implications for potential output measurement," ZEW Discussion Papers 14-067, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    14. repec:kap:empiri:v:44:y:2017:i:2:d:10.1007_s10663-016-9322-x is not listed on IDEAS
    15. Shaun de Jager & Michael Johnston & Rudi Steinbach, 2015. "Working Paper – WP/15/03- A Revised Quarterly Projection Model for South Africa," Papers 6839, South African Reserve Bank.
    16. repec:eee:ecosys:v:41:y:2017:i:3:p:389-407 is not listed on IDEAS
    17. Juan Carlos Berganza & Pedro del Río & Fructuoso Borrallo, 2016. "Determinants and implications of low global inflation rates," Occasional Papers 1608, Banco de España;Occasional Papers Homepage.
    18. Amador-Torres, J. Sebastián, 2017. "Finance-neutral potential output: An evaluation in an emerging market monetary policy context," Economic Systems, Elsevier, vol. 41(3), pages 389-407.

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    Keywords

    Potential output; output gap; Phillips curve; financial cycle;

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