The Output Gap: Measurement, Related Concepts and Policy Implications

Abstract

This paper compares the various approaches to the measurement of potential output and the NAIRU,j and identifies practical policy implications. The respective advantages an disadvantages of each method - the Okun's Law approach, the trend-fitting method, the production function approach, the simultaneous equations system method and the stochastic filter methods - are discussed in detail. It is noticed that the production function approach, despite obvious advantages in comaprison with the trend and the Okun's Law methods, has the drawback of relying on exogenous or trend values of NAIRU to get equilibrium values of labour inputs. Some of the weakness of this approach is niticed to be present even in the 'fully structural' system approach, which does not overcome the limitations of its individual component equations. In search of alternatives, the stochastic univariate and multivariate filter methods are compared to the structural methods. It is reasoned that the extended multivariate f...