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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Errors in the Measurement of the Output Gap and the Design of Monetary Policy
Athanasios Orphanides, Richard D. Porter, David Reifschneider, Robert Tetlow, and Frederico Finan

Abstract: We exploit data on historical revisions to real-time estimates of the output gap to examine the implications of measurement error for the design of monetary policy, using the Federal Reserve's model of the U.S. economy, FRB/US. Measurement error brings about a substantial deterioration in economic performance, although the problem can be mitigated somewhat by reducing the coefficient on the output gap in policy rules. We also show that it is usually optimal to place some weight on the level of the output gap in the conduct of policy, but under extreme conditions it may be preferable to focus on output growth.

Keywords: Interest rate rules, policy evaluation, output gap measurement

Full paper (145 KB PDF) | Full paper (1706 KB Postscript)

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Last update: January 27, 2000