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Output gaps, inflation and financial cycles in the United Kingdom

Author

Listed:
  • Melolinna, Marko

    () (Bank of England)

  • Tóth, Máté

    () (European Central Bank)

Abstract

This paper aims at constructing potential output and output gap measures for the United Kingdom which are pinned down by macroeconomic relationships as well as financial indicators. The exercise is based on a parsimonious unobserved components model which is estimated via Bayesian methods where the time-paths of unobserved variables are extracted with the Kalman filter. The resulting measures track current narratives on macroeconomic cycles and trends in the United Kingdom reasonably well. The inclusion of summary indicators of financial conditions leads to a more optimistic view on the path of UK potential output after the crisis and adds value to the model via improving its real-time performance. The models augmented with financial conditions have some inflation forecasting ability over the monetary policy relevant two to three-year horizon during the last fifteen years, although this ability diminishes in a real-time setting. Finally, we also introduce a new approach to constructing financial conditions indices, with emphasis on their real-time performance and ability to track the evolution of macrofinancial imbalances. Our results can be relevant from both monetary and macroprudential policy perspectives.

Suggested Citation

  • Melolinna, Marko & Tóth, Máté, 2016. "Output gaps, inflation and financial cycles in the United Kingdom," Bank of England working papers 585, Bank of England.
  • Handle: RePEc:boe:boeewp:0585
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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2016/output-gaps-inflation-and-financial-cycles-in-the-uk.pdf?la=en&hash=3195E0ECD1280D4C20F340E81EFF8FCA7D294D2A
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    References listed on IDEAS

    as
    1. Orphanides, Athanasios & van Norden, Simon, 2005. "The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 583-601, June.
    2. Michal Andrle, 2013. "What Is in Your Output Gap? Unified Framework & Decomposition into Observables," IMF Working Papers 13/105, International Monetary Fund.
    3. 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.
    4. Darracq Pariès, Matthieu & Maurin, Laurent & Moccero, Diego, 2014. "Financial conditions index and credit supply shocks for the euro area," Working Paper Series 1644, European Central Bank.
    5. Speigner, Bradley, 2014. "Long-term unemployment and convexity in the Phillips curve," Bank of England working papers 519, Bank of England.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Deba Prasad Rath & Pratik Mitra & Joice John, 2017. "A Measure of Finance-Neutral Output Gap for India," Working Papers id:11986, eSocialSciences.
    2. Mihnea Constantinescu & Anh Dinh Minh Nguyen, 2017. "Unemployment or Credit: Who Holds The Potential? Results From a Small-Open Economy," Bank of Lithuania Discussion Paper Series 4, Bank of Lithuania.

    More about this item

    Keywords

    Bayesian estimation; business cycle; forecasting; financial conditions; real-time data; unobserved components model.;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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