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Output Gaps in Real Time: Are They Reliable Enough to Use for Monetary Policy?

  • David Gruen

    (Reserve Bank of Australia)

  • Tim Robinson

    (Reserve Bank of Australia)

  • Andrew Stone

    (Reserve Bank of Australia)

The output gap – the difference between actual and potential output – is widely regarded as a useful guide to future inflationary pressures, as well as an important indicator of the state of the economy in its own right. Since the output gap is unobservable, however, its estimation is prone to error, particularly in real time. Errors result both from revisions to the underlying data, as well as from end-point problems that are endemic to econometric procedures used to estimate output gaps. These problems reduce the reliability of output gaps estimated in real time, and lead to questions about their usefulness. We examine 121 vintages of Australian GDP data to assess the seriousness of these problems. Our study, which is the first to address these issues using Australian data, is of interest for the method we use to obtain real-time output-gap estimates. Over the past 28 years, our real-time output-gap estimates show no apparent bias, when compared with final output-gap estimates derived with the benefit of hindsight using the latest available data. Furthermore, the root-mean-square difference between the real-time and final output-gap series is less than 2 percentage points, and the correlation between them is over 0.8. Our general conclusion is that quite good estimates of the output gap can be generated in real time, provided a sufficiently flexible and robust approach is used to obtain them.

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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2002-06.

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Date of creation: Sep 2002
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Handle: RePEc:rba:rbardp:rdp2002-06
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  1. Bennett T. McCallum, 2001. "Should Monetary Policy Respond Strongly to Output Gaps?," American Economic Review, American Economic Association, vol. 91(2), pages 258-262, May.
  2. Sargent, Thomas J, 1971. "A Note on the 'Accelerationist' Controversy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 3(3), pages 721-25, August.
  3. Douglas Laxton & Guy Debelle, 1996. "Is the Phillips Curve Really a Curve? Some Evidence for Canada, the United Kingdom, and the United States," IMF Working Papers 96/111, International Monetary Fund.
  4. Nelson, Edward & Nikolov, Kalin, 2003. "UK inflation in the 1970s and 1980s: the role of output gap mismeasurement," Journal of Economics and Business, Elsevier, vol. 55(4), pages 353-370.
  5. Glenn D. Rudebusch, 1999. "Is the Fed too timid? Monetary policy in an uncertain world," Working Papers in Applied Economic Theory 99-05, Federal Reserve Bank of San Francisco.
  6. Andrew Stone & Sharon Wardrop, 2002. "Real-time National Accounts Data," RBA Research Discussion Papers rdp2002-05, Reserve Bank of Australia.
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