Keywords: Phillips curve, output gap, inflation forecasts, real-time data
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.
Full paper (238 KB PDF)
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Last update: December 21, 2004