Potential Output: Concepts and Measurement - Department of Labour

Darren Gibbs 103
FIGURE 11: Estimated potential output and output gap series—multivariate
filter method
20
15
10000
Output gap (%)
10
5
0
-5
-10
-15
-20
8000
6000
4000
2000
0
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
Output ($m 82/83)
1992
1993
June years
mfb200: output gap (left axis)
mfb100,000: output gap (left axis)
mfb200: potential output (right axis)
mfb100,000: potential output (right axis)
mfb1600: output gap (left axis)
gdp (right axis)
mfb1600: potential output (right axis)
tightening in monetary policy (resulting in a positive yield gap: short rates
exceed long rates) tends to temporarily depress economic growth during the
transition to low inflation; or the fact that a positive yield gap may cause some
people to expect interest rates to fall in the near future with the result that some
investment projects are delayed (see Ebert, 1994).
The information contained in the IS regression was than embedded within the
Hodrick-Prescott minimisation formula (along with the Phillips curve and Okun
regression) to yield a multivariate estimate of potential output which is based on
both the observed behaviour of output and the observed behaviour of inflation,
unemployment and the yield curve. Again, an iterative technique was used to
generate successive replacement output gaps in the IS regression until the
estimated coefficients converged, and three variations of the smoothness parameter
were used so that three different multivariate filters were derived. Figure
11 illustrates the three estimated potential output series (mfb1600, mfb200,
mfb100,000) obtained by following the above approach, and the estimated output
gaps.
The general pattern of the multivariate output gaps is similar to the previous
estimates. However, the size of the negative output gap is less pronounced in the