Visualizing the Invisible: Estimating the New Keynesian Output Gap via a Bayesian Approach

Abstract

As the New Keynesian output gap cannot be observed, there is quite some debate on the question what this variable looks like. Rather than taking the standard approach of using a time trend or the HP-filter to estimate it, this paper separates trend from cycle via Bayesian estimation of a New Keynesian model, augmented with an unobserved components model for output. This provides us with a model consistent estimate of the output gap. This estimate is compared to popular proxies used in the literature. It turns out that the benefits of using the model-based approach mainly lie in real time.

Keywords: Bayesian estimation, unobserved components model, New Keynesian model, output gap, New Keynesian Phillips curve

JEL Classification: C53, E32, E37, E52