Output Gaps

57 Pages Posted: 14 Mar 2011  

Michael T. Kiley

Board of Governors of the Federal Reserve - Macroeconomic and Quantitative Studies Section

Date Written: May 1, 2010

Abstract

What is the output gap? There are many definitions in the economics literature, all of which have a long history. I discuss three alternatives: the deviation of output from its long-run stochastic trend (i.e., the "Beveridge-Nelson cycle"); the deviation of output from the level consistent with current technologies and normal utilization of capital and labor input (i.e., the "production-function approach"); and the deviation of output from "flexible-price" output (i.e., its "natural rate"). Estimates of each concept are presented from a dynamic-stochastic-general-equilibrium (DSGE) model of the U.S. economy used at the Federal Reserve Board. Four points are emphasized: The DSGE model's estimate of the Beveridge-Nelson gap is very similar to gaps from policy institutions, but the DSGE model's estimate of potential growth has a higher variance and substantially different covariance with GDP growth; the natural rate concept depends strongly on model assumptions and is not designed to guide nominal interest rate movements in "Taylor" rules in the same way as the other measures; the natural rate and production function trends converge to the Beveridge-Nelson trend; and the DSGE model's estimate of the Beveridge-Nelson gap is as closely related to unemployment fluctuations as those from policy institutions and has more predictive ability for inflation.

Keywords: Business Cycles, Potential Output

JEL Classification: E32, O41

Suggested Citation

Kiley, Michael T., Output Gaps (May 1, 2010). FEDS Working Paper No. 2010-27. Available at SSRN: https://ssrn.com/abstract=1783789 or http://dx.doi.org/10.2139/ssrn.1783789

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve - Macroeconomic and Quantitative Studies Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2448 (Phone)
202-452-5296 (Fax)

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