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Mr. Scacciavillani is an economist at the European Central Bank, and was an economist at the IMF when this paper was written. The authors thank Eric Clifton, Graham Hacche, Zvi Hercowitz, R. Barry Johnston, Tom Krueger, David W.H. Orsmond, Michel Strawczynski, and Hari Vittas for comments and suggestions, Peter Christoffersen, John McDermott, and Eswar Prasad for helpful conversations and for generously sharing computer programs, and Mandy Hemmati for research assistance.
See Thies (1991). Under this framework, fluctuations in output also occur due to changes in distortions introduced by factors such as the tax regime, protectionist measures, or labor market rigidities. The policy prescription in this case is to remove the distortion.
Cointegration is found only in the specification with a single lag, and this is not the “optimal” lag length suggested by the AIC criterion.
Indeed, Harvey and Jaeger (1993) uncover a series of spurious “stylized facts” using the HP filter. See Barrell and Sefton (1995) and Coe and McDermott (1997), among others, for further discussions of specific shortcomings. King and Rebelo (1993) illustrate the properties of the HP and low pass filters in general, including the stationarity of series examined. A problem with these critiques is typically the absence of a meaningful alternative for estimating potential output. One exception to this is the filter suggested by Coe and McDermott (1997), which relies on a kernel smoother with a data-dependent bandwidth selection rather than an arbitrary choice of smoothing parameter.
The Blanchard-Quah estimator is now in widespread use, so that the technical details are not repeated here.
A great deal of attention has focused on the issue of whether “supply” and “demand” are appropriate descriptions of the shocks identified by the Blanchard-Quah procedure. For example, Robertson and Wickens (1997) argue that “real” and “nominal” are a better nomenclature, since aggregate demand shocks do not affect output in the long run only in the unlikely case of a supply curve that is vertical at all time horizons. We do not take a stance on this issue other than to note that the Blanchard-Quah procedure can be viewed as simply an alternative filter with which to distinguish between permanent and transitory movements in the variables under analysis. Indeed, the only precise interpretation of the shocks is in terms of the restrictions by which they are defined, but this is enough for our purposes, since potential output is exactly about permanent movements in output, and thus by definition any deviation from potential output—any “output gap”—is attributable to a transitory shock.
The actual value of inflation is used for the first quarter. Inflation in 1999 is expected to fall back to 4 percent by the end of the year after the effects of the 1998 shekel devaluation are passed through. This gives values of year on year inflation of 7.0, 7.0, 7.6, and then 4.0 percent for the four quarters of 1999, where the final quarter is low because this is more than a year past the fall of the shekel.