The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
We argue that in an economy with downward nominal wage rigidity, the output gap is
negative on average. Because it is more difficult to cut wages than to increase them, firms
reduce employment more during downturns than they increase employment during
expansions. This is demonstrated in a simple New Keynesian model with asymmetric
wage adjustment costs. Using the model's output gap as a benchmark, we further show
that common output gap estimation methods exhibit a systematic bias because they
assume a zero mean. The bias is especially large in deep recessions when potential output
tends to be most severely underestimated.