Measuring Macroeconomic Stars: A Framework with Scarring Effects

Potential output and the natural rate of unemployment are commonly estimated through trend-cycle decompositions, where they are identified as underlying trends reflecting slow-moving supply factors. In this paper, we extend this framework to accommodate the possibility that cyclical disturbances affect trends endogenously through "scarring" effects. Two major changes occur relative to standard specifications. First, a significant share of business-cycle fluctuations is absorbed by endogenous movements in the trends rather than shifts in the cycle. Second, the estimated cycle--relieved of explaining the persistence in real variables--tracks inflation developments more closely, including through a steeper Phillips curve. While this steeper slope implies a strong co-movement between inflation and real activity in response to cyclical shocks, such strong co-movement is rarely apparent in the data. Consequently, the estimation shows a shift toward more sizable changes in the purely supply-driven components of the trends, mirrored by smaller innovations in the cycle process. In turn, this rebalancing entails different historical paths for the activity gaps, carrying important implications for the conduct of monetary policy.