DP14943 FAQ: How do I measure the Output gap?

Author(s): Fabio Canova
Publication Date: June 2020
Keyword(s): Cyclical fluctuations, Filtering, gain functions, Gaps and potentials, permanent and transitory components
JEL(s): C31, E27, E32
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14943

I investigate the properties of potentials and gaps, of permanent and transitory fluctuations using a variety of DSGE models. Model-based gaps display low frequency variations; have similar frequency representation as potentials, and are correlated with them. These features depend on the properties of the disturbances but not on frictions or modeling principles. Permanent and transitory fluctuations display similar features, but are uncorrelated. I use a number of filters to extract trends and cycles from simulated data. Distortions are large. Gaps are best approximated with a polynomial filter; transitory fluctuations with a differencing approach. I design a filter which reduces the biases of existing filters.