The case for fiscal stimulus in response to weaker activity is stronger in the United States than elsewhere: a significant output gap
is expected to open up; there is greater uncertainty about the normal transmission mechanism of monetary policy; interest rates are already low; and the automatic fiscal stabilisers are much weaker than in most other OECD economies, particularly those in Europe.
Notwithstanding these shortcomings and practical problems, output gaps
still appear--and are likely to continue appearing--in the inflation reports of many central banks.
It links output gap
y, defined as the percentage deviation of aggregate output from its potential level, to the difference between the real credit rate ([i.sub.c] - [Z.sup.e]) and real natural rate (i - [[pi].sup.e]) (9) The output gap
y is also affected by a demand shock [[epsilon].sub.d], which represents an exogenous shift in demand that arise from changes in consumption and/or investment.
The univariate UC trend yields positive output gaps
before the 1991, 2001, and 2007-09 recessions (albeit a much smaller positive gap leading into the 2007-09 recession).
Significant differences can be found among estimates of the output gaps
estimated in two types of data sets.
where i is the nominal interest rate, n is inflation, y is the output gap
, r* is the neutral real interest rate, and n* is the inflation target.
(2014), The production function methodology for calculating potential growth rates and output gaps
', European Economy, Economic Papers, 535.
Table 3 shows a simple version of that elasticity derived from regressing quarterly employment rates of prime-age males on the so-called output gap
(the percent difference between real GDP and potential GDP at full employment) along with a trend variable (to avoid assigning trend variation to the elasticity) and seasonal dummies.
Using Equation (10), we can investigate how the Federal Reserve responds to inflation and output gaps
in both the short and long run.
Figure 2 shows the sequence of output gaps
and inflation rates that minimize the central bank's loss function with these parameters when a temporarily negative natural rate of interest drives the economy to the ZLB in year zero.
The control of trend inflation then comes from the way in which the central bank's rule creates a stable nominal expectational environment that shapes the way in which firms in the "sticky" price sector set prices for multiple periods rather than through manipulation of an output gap
based on Phillips curve tradeoffs.
"Should growth turn out lower than expected, there is a risk that very large output gaps
would lead to deflation in some countries, with damaging consequences where debt burdens remain high," the IMF said in a document presented at a G20 meeting in Mexico last week.