Intuitive and Reliable Estimates of the Output Gap from a Beveridge-Nelson Filter

43 Pages Posted: 4 Oct 2016

See all articles by Güneş Kamber

Güneş Kamber

Bank for International Settlements (BIS) - Monetary and Economic Department

James Morley

University of Sydney

Benjamin Wong

Monash University - Department of Econometrics & Business Statistics

Multiple version iconThere are 4 versions of this paper

Date Written: September 2016

Abstract

The Beveridge-Nelson (BN) trend-cycle decomposition based on autoregressive forecasting models of U.S. quarterly real GDP growth produces estimates of the output gap that are strongly at odds with widely-held beliefs about the amplitude, persistence, and even sign of transitory movements in economic activity. These antithetical attributes are related to the autoregressive coefficient estimates implying a very high signal-to-noise ratio in terms of the variance of trend shocks as a fraction of the overall quarterly forecast error variance. When we impose a lower signal-to-noise ratio, the resulting BN decomposition, which we label the "BN filter", produces a more intuitive estimate of the output gap that is large in amplitude, highly persistent, and typically positive in expansions and negative in recessions. Real-time estimates from the BN filter are also reliable in the sense that they are subject to smaller revisions and predict future output growth and inflation better than for other methods of trend-cycle decomposition that also impose a low signal-to-noise ratio, including deterministic detrending, the Hodrick-Prescott filter, and the bandpass filter.

Keywords: Beveridge-Nelson decomposition, output gap, signal-to-noise ratio

JEL Classification: C18, E17, E32

Suggested Citation

Kamber, Gunes and Morley, James and Wong, Benjamin, Intuitive and Reliable Estimates of the Output Gap from a Beveridge-Nelson Filter (September 2016). BIS Working Paper No. 584. Available at SSRN: https://ssrn.com/abstract=2841400

Gunes Kamber (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

James Morley

University of Sydney ( email )

Rm 370 Merewether (H04)
Sydney, NSW 2006 2008
Australia

HOME PAGE: http://https://sites.google.com/site/jamescmorley/

Benjamin Wong

Monash University - Department of Econometrics & Business Statistics ( email )

Wellington Road
Clayton, Victoria 3168
Australia

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