Série Scientifique Scientific Series the Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time the Reliability of Inflation Forecasts Based on Output Gap Estimates in Real Time*

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.

[1]  C. Nelson,et al.  A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the ‘business cycle’☆ , 1981 .

[2]  Athanasios Orphanides,et al.  Historical Monetary Policy Analysis and the Taylor Rule , 2003 .

[3]  Olivier J. Blanchard,et al.  The Dynamic Effects of Aggregate Demand and Supply Disturbances , 1988 .

[4]  Todd E. Clark,et al.  The Predictive Content of the Output Gap for Inflation: Resolving In-Sample and Out-of-Sample Evidence , 2003 .

[5]  Filtering for Current Analysis , 2002 .

[6]  G. Bush.  Economic Report of the President , 2001 .

[7]  K. West,et al.  Asymptotic Inference about Predictive Ability , 1996 .

[8]  Kenneth N. Kuttner.  Estimating Potential Output as a Latent Variable , 1994 .

[9]  C. Mann,et al.  Evaluating Policy Regimes: New Research in Empirical MacRoeconomics , 1993 .

[10]  Jeremy Piger,et al.  The Use and Abuse of 'Real-Time' Data in Economic Forecasting , 2000 .

[11]  R. Lalonde,et al.  Une nouvelle méthode d'estimation de l'écart de production et son application aux États-Unis, au Canada et à l'Allemagne , 1998 .

[12]  Athanasios Orphanides.  The Quest for Prosperity Without Inflation , 2000, SSRN Electronic Journal.

[13]  Athanasios Orphanides.  Monetary Policy Rules, Macroeconomic Stability, and Inflation: A View from the Trenches , 2001, SSRN Electronic Journal.

[14]  Mark W. Watson,et al.  Univariate detrending methods with stochastic trends , 1986 .

[15]  P. Clark,et al.  The Cyclical Component of U. S. Economic Activity , 1987 .

[16]  Athanasios Orphanides,et al.  The Unreliability of Output-Gap Estimates in Real Time , 2002, Review of Economics and Statistics.

[17]  John B. Taylor.  Monetary Policy Rules , 1999 .

[18]  S. V. Norden,et al.  Measurement of the Output Gap: A Discussion of Recent Research at the Bank of Canada , 1997 .

[19]  E. Prescott,et al.  Postwar U.S. Business Cycles: An Empirical Investigation , 1997 .

[20]  S. Kozicki.  Multivariate detrending under common trend restrictions: Implications for business cycle research , 1999 .

[21]  Athanasios Orphanides,et al.  The Reliability of Output Gap Estimates in Real Time , 1999 .

[22]  Timothy Cogley,et al.  Effects of the Hodrick-Prescott filter on trend and difference stationary time series Implications for business cycle research , 1995 .

[23]  B. Mccallum.  Should Monetary Policy Respond Strongly to Output Gaps? , 2001 .

[24]  W. Newey,et al.  A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelationconsistent Covariance Matrix , 1986 .

[25]  Jonas D. M. Fisher,et al.  When Can We Forecast Inflation , 2002 .

[26]  Marianne Baxter,et al.  Measuring Business Cycles Approximate Band-Pass Filters for Economic Time Series , 1999 .

[27]  Simon van Norden.  Why Is It So Hard To Measure the Current Output Gap , 1995 .

[28]  Dean Croushore,et al.  A real-time data set for macroeconomists , 2001 .

[29]  D. Romer,et al.  Reducing inflation : motivation and strategy , 1997 .

[30]  Todd E. Clark,et al.  Evaluating Long – Horizon Forecasts ∗ , 2004 .

[31]  Edmund Taylor Whittaker.  On a New Method of Graduation , 1922, Proceedings of the Edinburgh Mathematical Society.

[32]  Jean-Philippe Cayen,et al.  La fiabilité des estimations de l'écart de production au Canada , 2002 .

[33]  Todd E. Clark,et al.  Tests of Equal Forecast Accuracy and Encompassing for Nested Models , 1999 .

[34]  Sergio Rebelo,et al.  Low Frequency Filtering And Real Business Cycles , 1993 .

[35]  P. Newbold,et al.  Tests for Forecast Encompassing , 1998 .

[36]  Andrew Harvey,et al.  Trends and Cycles in Macroeconomic Time Series , 1985 .

[37]  C. Nelson,et al.  Trends and random walks in macroeconmic time series: Some evidence and implications , 1982 .

[38]  A. Atkeson,et al.  Are Phillips Curves Useful for Forecasting Inflation , 2001 .

[39]  A. Harvey,et al.  Detrending, stylized facts and the business cycle , 1993 .

[40]  L. Kilian,et al.  In-Sample or Out-of-Sample Tests of Predictability: Which One Should We Use? , 2002, SSRN Electronic Journal.

[41]  J. Stock,et al.  The NAIRU, Unemployment and Monetary Policy , 1997 .

[42]  Todd E. Clark.  Business cycle fluctuations in U.S. regions and industries: the roles of national, region-specific, and industry-specific shocks , 1992 .

[43]  J. Stock,et al.  Evidence on Structural Instability in Macroeconomic Time Series Relations , 1994 .

[44]  Marianne Baxter,et al.  Measuring Business Cycles: Approximate Band-Pass Filters for Economic Time Series , 1995, Review of Economics and Statistics.

[45]  J. Stock,et al.  How Precise are Estimates of the Natural Rate of Unemployment? , 1996 .

[46]  Andrew Harvey,et al.  Forecasting, Structural Time Series Models and the Kalman Filter , 1990 .

[47]  Eric Zivot,et al.  Why Are the Beveridge-Nelson and Unobserved-Components Decompositions of GDP So Different? , 2003, Review of Economics and Statistics.

[48]  A. Harvey,et al.  General Model-Based Filters for Extracting Cycles and Trends in Economic Time Series , 2003, Review of Economics and Statistics.

[49]  F. Diebold,et al.  Comparing Predictive Accuracy , 1994, Business Cycles.

[50]  C. Walsh.  research platform to scholars worldwide. Implications of a Changing Economic Structure for the Strategy of Monetary Policy , 2004 .

[51]  Simon van Norden,et al.  The reliability of inflation forecasts based on output gap estimates in real time , 2004 .