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Effects of Measurement Error on the Output Gap in Japan

Author

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  • Koichiro Kamada

    (Bank of Japan)

  • Kazuto Masuda

    (Bank of Japan)

Abstract

Potential output is the largest amount of products that can be produced by fully utilizing available labor and capital stock; the output gap is defined as the discrepancy between actual and potential output. If data on production factors contain measurement errors, total factor productivity (TFP) cannot be estimated accurately from the Solow residual (i.e., the portion of output that is not attributable to labor and capital inputs). This may give rise to distortions in the estimation of potential output and output gap. The primary purpose of this paper is to discuss theoretically how measurement errors and quality changes in production factors affect estimates of potential output and the output gap. The main results are (i) that effects of quality changes in production factors can be left in the Solow residual for correct estimation of potential output and the output gap, but (ii) that measurement errors in utilization of capital stock and labor should be removed. Estimation of Japan's output gap, in particular, may be distorted by the absence of data on capacity utilization in non-manufacturing sectors. To resolve this problem, we consider two definitions of output gap and compare their performance. The first definition (the conventional output gap) assumes capacity utilization to be 100% in non-manufacturing sectors. Then we fit a certain trend to the Solow residual and define the trend as TFP and the regression residual as capacity utilization in non-manufacturing sectors. The second definition (the new output gap) uses data on electricity consumption to directly estimate capacity utilization in non-manufacturing sectors. In this case, we can take the Solow residual to be TFP. Next, we compare the performance of the two definitions of output gap in terms of their consistency with reference dates of business cycle and with various DIs in Short-term Economic Survey of Enterprises in Japan published by the Bank of Japan, including business conditions DI. We show that the "new output gap" is superior to the "conventional output gap." Furthermore, when the new output gap is used in a Phillips curve, estimates of parameters are more stable than when we use the conventional output gap. These results suggest that the new output gap is a suitable measure of slackness in the Japanese economy.

Suggested Citation

  • Koichiro Kamada & Kazuto Masuda, 2000. "Effects of Measurement Error on the Output Gap in Japan," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
    • Handle: RePEc:boj:bojwps:00-e-15r
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    Cited by:

    1. Shiratsuka, Shigenori, 2001. "Is There a Desirable Rate of Inflation? A Theoretical and Empirical Survey," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(2), pages 49-83, May.
    2. Kameda, Keigo, 2014. "What causes changes in the effects of fiscal policy? A case study of Japan," Japan and the World Economy, Elsevier, vol. 31(C), pages 14-31.
    3. Nadenichek, Jon, 2007. "Consumer confidence and economic stagnation in Japan," Japan and the World Economy, Elsevier, vol. 19(3), pages 338-346, August.
    4. Research and Statistics Department, 2003. "The Output Gap and the Potential Growth Rate:Issues and Applications as an Indicator for the Pressure on Price Change," Bank of Japan Research Papers 2003-05-09, Bank of Japan.
    5. Kamada, Koichiro, 2005. "Real-time estimation of the output gap in Japan and its usefulness for inflation forecasting and policymaking," The North American Journal of Economics and Finance, Elsevier, vol. 16(3), pages 309-332, December.
    6. Hideo Hayakawa & Hiroshi Ugai, 2001. "Why did prices in Japan hardly decline during the 1997-98 recession?," BIS Papers chapters, in: Bank for International Settlements (ed.), Empirical studies of structural changes and inflation, volume 3, pages 139-173, Bank for International Settlements.
    7. Yasuo Hirose & Koichiro Kamada, 2002. "Time-Varying NAIRU and Potential Growth in Japan," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
    8. Hirose, Yasuo & Kamada, Koichiro, 2003. "A New Technique for Simultaneous Estimation of Potential Output and the Phillips Curve," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 21(2), pages 93-112, August.
    9. Ichiro Muto, 2009. "Estimating A New Keynesian Phillips Curve With A Corrected Measure Of Real Marginal Cost: Evidence In Japan," Economic Inquiry, Western Economic Association International, vol. 47(4), pages 667-684, October.
    10. Masao Tsuri, 2005. "Discretionary deficit and its effects on Japanese economy," Applied Economics, Taylor & Francis Journals, vol. 37(19), pages 2239-2249.
    11. Colombo, Emilio & Onnis, Luisanna & Tirelli, Patrizio, 2016. "Shadow economies at times of banking crises: Empirics and theory," Journal of Banking & Finance, Elsevier, vol. 62(C), pages 180-190.
    12. Tomomi Miyazaki & Kazuki Hiraga & Masafumi Kozuka, 2018. "Stock Market Response to Public Investment under the Zero Lower Bound: Cross-industry Evidence from Japan," Working Papers 171806, University of California-Irvine, Department of Economics.
    13. Hiraga, Kazuki & Kozuka, Masafumi & Miyazaki, Tomomi, 2018. "Public capital and asset prices: Time-series evidence from Japan," Finance Research Letters, Elsevier, vol. 25(C), pages 172-176.
    14. SHINADA Naoki, 2011. "Quality of Labor, Capital, and Productivity Growth in Japan: Effects of employee age, seniority, and capital vintage," Discussion papers 11036, Research Institute of Economy, Trade and Industry (RIETI).
    15. Fujiwara, Ippei & Hara, Naoko & Hirose, Yasuo & Teranishi, Yuki, 2005. "The Japanese Economic Model (JEM)," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 23(2), pages 61-142, May.
    16. Yoichi Matsubayashi, 2009. "Structural and Cyclical Movements of the Current Account in the U.S. 1976-2007," Discussion Papers 0829, Graduate School of Economics, Kobe University.
    17. Takashi Kozu & Yoshiko Sato & Masakazu Inada, 2003. "Demographic Changes in Japan and their Macroeconomic Effects," Bank of Japan Working Paper Series 04-E-6, Bank of Japan.
    18. Koichiro Kamada & Naohisa Hirakata, 2002. "Import Penetration and Consumer Prices," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
    19. repec:kob:wpaper:1625 is not listed on IDEAS
    20. Shigenori Shiratsuka, 2001. "Asset prices, financial stability and monetary policy: based on Japan’s experience of the asset price bubble," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 261-284, Bank for International Settlements.
    21. Yasuo Hirose & Koichiro Kamada, 2001. "A New Technique for Simultaneous Estimation of the Output Gap and Phillips Curve," Bank of Japan Working Paper Series Research and Statistics D, Bank of Japan.
    22. Mr. Se-Jik Kim, 2003. "Macro Effects of Corporate Restructuring in Japan," IMF Working Papers 2003/203, International Monetary Fund.
    23. Matsubayashi, Yoichi, 2006. "Structural and cyclical movements of the current account in Japan: An alternative measure," Japan and the World Economy, Elsevier, vol. 18(4), pages 545-567, December.
    24. Yuki Teranishi, 2003. "Zero Bound on Nominal Interest Rates and Ex Ante Positive Inflation: A Cost Analysis," Bank of Japan Working Paper Series 03-E-8, Bank of Japan.
    25. Iichiro Uesugi & Guy M. Yamashiro, 2004. "How Trade Credit Differs from Loans: Evidence from Japanese Trading Companies," Discussion papers 04028, Research Institute of Economy, Trade and Industry (RIETI).

    More about this item

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • O47 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence
    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General

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