The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time

30 Pages Posted: 27 Jan 2005

See all articles by Simon van Norden

Simon van Norden

HEC Montreal - Department of Finance; CIRANO; University of Montreal - Center for Interuniversity Research in Econometrics

Athanasios Orphanides

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Asia School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: November 2004

Abstract

A stable predictive relationship between inflation and the output gap, often referred to as a Phillips curve, provides the basis for countercyclical monetary policy in many models. In this paper, we evaluate the usefulness of alternative univariate and multivariate estimates of the output gap for predicting inflation. Many of the ex post output gap measures we examine appear to be quite useful for predicting inflation. However, forecasts using real-time estimates of the same measures do not perform nearly as well. The relative usefulness of real-time output gap estimates diminishes further when compared to simple bivariate forecasting models which use past inflation and output growth. Forecast performance also appears to be unstable over time, with models often performing differently over periods of high and low inflation. These results call into question the practical usefulness of the output gap concept for forecasting inflation.

Keywords: Phillips curve, output gap, inflation forecasts, real-time data

JEL Classification: E37, C53

Suggested Citation

van Norden, Simon and Orphanides, Athanasios, The Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time (November 2004). Available at SSRN: https://ssrn.com/abstract=655230 or http://dx.doi.org/10.2139/ssrn.655230

Simon Van Norden

HEC Montreal - Department of Finance ( email )

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CIRANO ( email )

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University of Montreal - Center for Interuniversity Research in Econometrics ( email )

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Athanasios Orphanides (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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E62-416
Cambridge, MA 02142
United States

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=54058

Asia School of Business ( email )

Jalan Kuching, Kuala Lumpur, Wilayah Persekutuan K
Kuala Lumpur, MA
Malaysia

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