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The reliability of inflation forecasts based on output gap estimates in real time

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  • Athanasios Orphanides
  • Simon van Norden

Abstract

A stable predictive relationship between inflation and the output gap, often referred to as a Phillips curve, provides the basis for countercyclical monetary policy in many models. In this paper, we evaluate the usefulness of alternative univariate and multivariate estimates of the output gap for predicting inflation. Many of the ex post output gap measures we examine appear to be quite useful for predicting inflation. However, forecasts using real-time estimates of the same measures do not perform nearly as well. The relative usefulness of real-time output gap estimates diminishes further when compared to simple bivariate forecasting models which use past inflation and output growth. Forecast performance also appears to be unstable over time, with models often performing differently over periods of high and low inflation. These results call into question the practical usefulness of the output gap concept for forecasting inflation.

Suggested Citation

  • Athanasios Orphanides & Simon van Norden, 2004. "The reliability of inflation forecasts based on output gap estimates in real time," Finance and Economics Discussion Series 2004-68, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2004-68
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    More about this item

    Keywords

    Inflation (Finance); Phillips curve; Input-output analysis;
    All these keywords.

    JEL classification:

    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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