Mind the Gap: What is the Best Measure of Slack in the Euro Area?

December 1, 2001

Preview Citation

Format: Chicago

Angel J. Ubide, and Kevin Ross. Mind the Gap: What is the Best Measure of Slack in the Euro Area?, (USA: International Monetary Fund, 2001) accessed October 6, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Assessing the magnitude of the output gap is critical to achieving an optimal policy mix. Unfortunately, the gap is an unobservable variable, which, in practice, has been estimated in a variety of ways, depending on the preferences of the modeler. This model selection problem leads to a substantial degree of uncertainty regarding the magnitude of the output gap, which can reduce its usefulness as a policy tool. To overcome this problem, in this paper we attempt to insert some discipline into this search by providing two metrics-inflation forecasting and business cycle dating-against which different options can be evaluated using aggregated euro-area GDP data. Our results suggest that Gali, Gertler, and Lopez-Salido's (2001) inefficiency wedge performs best in inflation forecasting and production function methodology dominates in the prediction of turning points. If, however, a unique methodology must be selected, the quadratic trend delivers the best overall results.

Subject: Business cycles, Economic forecasting, Economic growth, Inflation, Output gap, Potential output, Prices, Production

Keywords: BB procedure, Business cycle, Business cycles, Consumer confidence, Detrending method, Forecasting exercise, Hodrick-Prescott method, Inflation, Inflation dynamics, Inflation performance criteria, Inflation regression, Method abbreviation, Non-stationary output gap, Output gap, Output gap estimate, Output gap measure, Output gaps, Phillips curve, Potential output, Production function, Survey method, Unobservable components, WP

Publication Details

Pages:

36
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2001/203
Stock No:

WPIEA2032001
ISBN:

9781451874457
ISSN:

1018-5941

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