The third section describes the data and reports dynamic factor model estimation results for national budget surpluses, output gaps
, equity valuation ratios, unexpected inflation, and military spending.
The output gaps
obtained based on the estimated model differ substantially from those calculated with the univariate version of the HP filter.
Figure 2 reproduces the inflation and output gap
consistent with the historical data as available up to 1970Q2, and staff forecasts for subsequent quarters as shown in the Greenbook.
Since future interest rates determine future inflation rates and output gaps
, the only terms in the central bank's loss function under its current control give the current loss, 1/2 ([[pi].
For the large output gaps
to be closed will require that higher than current levels will need to be sustained for some time," said analysts at ANZ Research.
If the coefficient on the output gap
is constant when we roll our estimation period across time, then we'll have a stable version of Okun's law.
According to their estimates, the output gaps
have been negative at all times since the middle of the 1990s, so that they might not be successful in illustrating the business cycles and overall macroeconomic conditions.
If the lagged funds rate is important because it is a short-hand way of saying that policy responds to a weighted average of past inflations and past output gaps
, today's funds rate does not depend on yesterday's funds rate, but what policy would have been if the zero lower bound were not present.
A]lthough output gaps
are of course very hard to measure, the weight of the evidence continues to support those who believe that considerable slack remains in the economy.
Notwithstanding these shortcomings and practical problems, output gaps
still appear--and are likely to continue appearing--in the inflation reports of many central banks.
McKeown (2004): "The informational content of empirical measures of real interest rate and output gaps
for the United Kingdom", Working Paper 224, Bank of England
Back in 1999, during what turned out to be the middle of the last boom period, OECD and IMF estimates showed negative output gaps
, implying that the economy was running well below capacity.