Working Paper: CEPR ID: DP4830
Authors: Athanasios Orphanides; Simon van Norden
Abstract: A stable predictive relationship between inflation and the output gap, often referred to as a Phillips curve, provides the basis for countercyclical monetary policy in many models. In this paper, we evaluate the usefulness of alternative univariate and multivariate estimates of the output gap for predicting inflation. Many of the ex post output gap measures we examine appear to be quite useful for predicting inflation. However, forecasts using real-time estimates of the same measures do not perform nearly as well. The relative usefulness of real-time output gap estimates diminishes further when compared to simple bivariate forecasting models which use past inflation and output growth. Forecast performance also appears to be unstable over time, with models often performing differently over periods of high and low inflation. These results call into question the practical usefulness of the output gap concept for forecasting inflation.
Keywords: inflation forecasts; output gap; Phillips curve; real-time data
JEL Codes: C53; E37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| output gap (E23) | inflation (E31) |
| reliability of output gap measures (E24) | accuracy of inflation forecasts (E31) |
| real-time output gap estimates (C51) | accuracy of inflation forecasts (E31) |
| output gap estimates (E23) | forecasting accuracy compared to simpler models (C53) |