Mind the Gap: What is the Best Measure of Slack in the Euro Area?
Electronic Access:
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Summary:
Assessing the magnitude of the output gap is critical to achieving an optimal policy mix. Unfortunately, the gap is an unobservable variable, which, in practice, has been estimated in a variety of ways, depending on the preferences of the modeler. This model selection problem leads to a substantial degree of uncertainty regarding the magnitude of the output gap, which can reduce its usefulness as a policy tool. To overcome this problem, in this paper we attempt to insert some discipline into this search by providing two metrics-inflation forecasting and business cycle dating-against which different options can be evaluated using aggregated euro-area GDP data. Our results suggest that Gali, Gertler, and Lopez-Salido's (2001) inefficiency wedge performs best in inflation forecasting and production function methodology dominates in the prediction of turning points. If, however, a unique methodology must be selected, the quadratic trend delivers the best overall results.
Series:
Working Paper No. 2001/203
Subject:
Business cycles Economic forecasting Economic growth Inflation Output gap Potential output Prices Production
English
Publication Date:
December 1, 2001
ISBN/ISSN:
9781451874457/1018-5941
Stock No:
WPIEA2032001
Pages:
36
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