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Pitfalls in monetary policy decisions based on the output gap

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  • Coutiño, Alfredo

Abstract

In many countries monetary policy decisions are based on the output gap. In particular, monetary easing is usually justified by citing slack in the economy. However, the use of subjective information can result in an inaccurate estimate of the output gap, and its partial interpretation can lead to a wrong monetary decision. This paper establishes that monetary decisions can be inconsistent when they are based on an output gap estimated with the HP filter with tail correction and when policymakers assume that a negative gap does always indicate weakness in demand. We suggest that monetary policymakers should use several methods and approaches, with the purpose of taking decisions with the most complete and accurate information available.

Suggested Citation

  • Coutiño, Alfredo, 2016. "Pitfalls in monetary policy decisions based on the output gap," Journal of Policy Modeling, Elsevier, vol. 38(1), pages 54-64.
    • Handle: RePEc:eee:jpolmo:v:38:y:2016:i:1:p:54-64
    DOI: 10.1016/j.jpolmod.2015.08.007
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    References listed on IDEAS

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    1. Kenneth F. Wallis, 2008. "Forecast Uncertainty, Its Representation And Evaluation," World Scientific Book Chapters, in: Roberto S Mariano & Yiu-Kuen Tse (ed.), Econometric Forecasting And High-Frequency Data Analysis, chapter 1, pages 1-51, World Scientific Publishing Co. Pte. Ltd..
    2. Marianne Baxter & Robert G. King, 1999. "Measuring Business Cycles: Approximate Band-Pass Filters For Economic Time Series," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 575-593, November.
    3. Pierre St-Amant & Simon van Norden, 1997. "Measurement of the Output Gap: A Discussion of Recent Research at the Bank of Canada," Technical Reports 79, Bank of Canada.
    4. Albert Marcet & Morte O. Ravn, "undated". "The HP-Filter in Cross-Country Comparisons," Studies on the Spanish Economy 100, FEDEA.
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    Cited by:

    1. Coutino, Alfredo, 2023. "Fed's monetary policy mistake and the US post-COVID economic recovery," Journal of Policy Modeling, Elsevier, vol. 45(3), pages 669-676.

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    More about this item

    Keywords

    Monetary policy; Interest rates; Potential GDP; Output gap; HP filter;
    All these keywords.

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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