The Reliability of Output-Gap Estimates in Real Time

• Activity Number: 490
• Type: Topic Contributed
• Date/Time: Wednesday, August 6, 2014 : 10:30 AM to 12:20 PM
• Sponsor: Business and Economic Statistics Section
• Author(s): Elmar Mertens*+
• Companies: Board of Governors of the Federal Reserve System
• Keywords: Output Gap ; Trend Cycle Decomposition ; Realtime Data ; Stochastic Volatility ; Bayesian Estimation

Abstract

Realtime estimates of the Output Gap -- defined as the cyclical component of GDP -- have previously been shown to be unreliable, since they are subject to large revisions when new data comes in. However, this result has so far only been derived for constant parameter models. This paper uses statistical models where the volatility of shocks to trend and cycle can vary over time. In this case, output gap estimates derived from data vintages going back to the 1970s are remarkably close to final estimates derived from all available sample data. The final estimates not only fall mostly within the confidence sets generated by the realtime data, these confidence sets are also considerably tighter when estimated from a model with stochastic volatility. These results are established from a simple bivariate model, using real GDP and the unemployment rate. As a by-product, the model also documents time-variation in Okun s Law.