The Commission Services’ Cyclical Adjustment Method

Abstract

The authors present the Hodrick Prescott filter and characterize its main features. The selection of the smoothing parameter and its impact on the extraction of the cyclical component are examined more closely. Attention is also given to the so-called end point bias problem. The Hodrick Prescott filter is then compared to other trend estimation methods, such as the band pass filter, linear time trend methods and the production function approach. The output gap estimates resulting from these different methods are compared to other business cycle indicators, such as the degree of capacity utilization and the producer sentiment indicator. Ongena and Röger stress that output gap estimates obtained via the European Commission’s QUEST production function are used to check the plausibility of the results obtained via the HP filter.