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The Output Gap and Its Role in Inflation-Targeting in the Philippines

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  • Yap, Josef T.

Abstract

The output gap is the difference between the economy’s actual output and potential output, with the latter being the level of production consistent with existing labor, capital and technology. There are several key issues surrounding the output gap in the context of inflation-targeting. One is whether the central bank should consider the output gap in addition to the inflation target in setting monetary policy. However, this is not addressed in the present paper. Another issue is the appropriate technique to estimate the output gap of which there are three broad groups: the atheoretical or time series approach, the structural approach, and the mixed or multivariate approach. Even if the output gap can be estimated within an acceptable degree of precision, it has to be determined empirically whether it should be included in an inflation-forecasting model. Applying quarterly Philippine GDP data, three estimates of the output gap were obtained from (i) a linear time trend model, (ii) an application of the Hodrick-Prescott filter, and (iii) an unobserved components mode. All three measures add significant explanatory power to an inflation equation that is specified in Error Correction form.

Suggested Citation

  • Yap, Josef T., 2003. "The Output Gap and Its Role in Inflation-Targeting in the Philippines," Discussion Papers DP 2003-10, Philippine Institute for Development Studies.
    • Handle: RePEc:phd:dpaper:dp_2003-10
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    File URL: https://www.pids.gov.ph/publication/discussion-papers/the-output-gap-and-its-role-in-inflation-targeting-in-the-philippines
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    References listed on IDEAS

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    1. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
    2. Camba-Mendez, Gonzalo & Rodriguez-Palenzuela, Diego, 2003. "Assessment criteria for output gap estimates," Economic Modelling, Elsevier, vol. 20(3), pages 529-562, May.
    3. W A Razzak, 2002. "Monetary policy and forecasting inflation with and without the output gap," Reserve Bank of New Zealand Discussion Paper Series DP2002/03, Reserve Bank of New Zealand.
    4. Favero, Carlo A., 2001. "Applied Macroeconometrics," OUP Catalogue, Oxford University Press, number 9780198296850.
    5. Gordon de Brouwer, 1998. "Estimating Output Gaps," RBA Research Discussion Papers rdp9809, Reserve Bank of Australia.
    6. Chantal Dupasquier & Alain Guay & Pierre St-Amant, 1997. "A Comparison of Alternative Methodologies for Estimating Potential Output and the Output Gap," Staff Working Papers 97-5, Bank of Canada.
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    Cited by:

    1. Christopher CRUZ & Claire MAPA, 2013. "An Early Warning System For Inflation In The Philippines Using Markov-Switching And Logistic Regression Models," Theoretical and Practical Research in the Economic Fields, ASERS Publishing, vol. 4(2), pages 136-150.
    2. Andrés Felipe Giraldo Palomino, 2008. "Aversión a la inflación y regla de Taylor en Colombia 1994-2005," Revista Cuadernos de Economia, Universidad Nacional de Colombia, FCE, CID, December.
    3. Nkuna, Onelie, 2013. "Sustainability of the Malawian Current Account Deficit: Application of Structural and Solvency Approaches," MPRA Paper 51919, University Library of Munich, Germany.

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