How Informative Are Real Time Output Gap Estimates in Europe?

IMF Working Papers, September 20, 2019

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Study period: 1994-2017.
Staff typically saw economies as operating below their potential.
In real time, output gaps tend to have large and negative averages that are largely revised away in later vintages.
Most of the mis-measurement in real time can be explained by:
- the difficulty in predicting recessions, and
- overestimation of the economy’s potential capacity.
Real-time output gaps are not useful for predicting inflation (finding consistent with earlier literature).
Countries where slack (and potential growth) is overestimated to a larger extent tend to have:
- lower primary fiscal balances, and
- higher public debt ratios that increase faster than projected.
Previous research suggests national authorities’ real-time output gaps suffer from a similar bias.
Policy implication: To the extent real-time output gap estimates play a role in calibrating fiscal policy, over-optimism about long-term growth could contribute to excessive deficits and debt buildup.

Subject areas: Fiscal policy, Fiscal stance, Inflation, Output gap, Potential output, Prices, Production.
Keywords: Business Cycles, debt buildup, Europe, Fiscal Policy, Fiscal stance, Inflation, mean output gap property, Monetary Policy, Output gap, output gap bias, output gap estimate, output gap revision, Potential Output, real-time estimate, real-time output gaps, WP.
Publication type: IMF Working Papers.
Authors: Alvar Kangur, Koralai Kirabaeva, Jean-Marc Natal, Simon Voigts.
Publication date: September 20, 2019.
Pages: 42.