Measuring Output Gap: Is it Worth Your Time?

Abstract

We apply a range of models to the U.K. data to obtain estimates of the output gap. A structural VAR with an appropriate identification strategy provides improved estimates of output gap with better real time properties and lower sensitivity to temporary shocks than the usual filtering techniques. It also produces smaller out-of-sample forecast errors for inflation. At the same time, however, our results suggest caution in basing policy decisions on output gap estimates.

Keywords: Potential output, Supply and demand, Economic theory, Real interest rates, Business cycles, output gaps, real time estimation, business cycles., WP, output gap, supply shock, filter method, type of shock, GFC

JEL Classification: E2, E3, E6, E01, O24, D4, E52, E31