An Inflation-Predicting Measure of the Output Gap in the Euro Area

42 Pages Posted: 18 Oct 2016

See all articles by Marek Jarocinski

Marek Jarocinski

European Central Bank (ECB)

Michele Lenza

European Central Bank (ECB)

Date Written: September 19, 2016

Abstract

Using a small Bayesian dynamic factor model of the euro area we estimate the deviations of output from its trend that are consistent with the behavior of inflation. We label these deviations the output gap. In order to pin-down the features of the model, we evaluate the accuracy of real-time inflation forecasts from different model specifications. The version that forecasts inflation best implies that after the 2011 sovereign debt crisis the output gap in the euro area has been much larger than the official estimates. Versions featuring a secular-stagnation-like slowdown in trend growth, and hence a small output gap after 2011, do not adequately capture the inflation developments.

Keywords: Phillips curve, factor model, unobserved components, Bayesian estimation

JEL Classification: C32, C53, E31, E32, E37

Suggested Citation

Jarocinski, Marek and Lenza, Michele, An Inflation-Predicting Measure of the Output Gap in the Euro Area (September 19, 2016). ECB Working Paper No. 1966. Available at SSRN: https://ssrn.com/abstract=2854038

Marek Jarocinski (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany
+49 69 1344 6414 (Phone)

Michele Lenza

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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