VI. Appendix: Maximum Regularized Likelihood
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The estimates contained in this paper are not official IMF estimates. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy. We thank Olivier Blanchard, Charles Collyns, Marcello Estevao, Koshy Mathai and David Romer for useful discussions and comments. We also thank Ioan Carabenciov, Susanna Mursula, and Kadir Tanyeri for their excellent research assistance. Kevin Clinton is a Visiting Scholar in the Research Department and Marianne Johnson is a Research Advisor at the Bank of Canada. The remaining authors work in the Fund’s Economic Modeling Unit of the Research Department. The estimates of the output gap and potential output as well as the programs used to construct such estimates can be downloaded from www.douglaslaxton.org.
Mismeasurement of the output gap contributed importantly to the in inflationary monetary policy errors of the 1970s. See Freedman (1989), Laxton and Tetlow (1992) and Orphanides (2001). Barnett, Kozicki, and Petrinec (2009) point out the usefulness of the output gap as a tool for policy communications.
Orphanides (2001) underlines the large margin for error involved in real-time estimates of the output gap.
See, for example, Laxton and Tetlow (1992) and Kuttner (1994). A parallel strand of research, on the measurement of the equilibrium rate of unemployment, or NAIRU, has also used the behavior of inflation to identify an underlying, equilibrium variable – for example, Blanchard and Summers (1986), Fortin (1991) and Ball (2009).
In future work, we envisage incorporating an explicit expectations process.
Okun made a working assumption, which he recognized was somewhat arbitrary, that the “target” rate of unemployment was 4 percent. In modern parlance, one would say that he assumed a stable NAIRU.
Blanchard and Summers (1986) introduced the idea of hysteresis to the behavior of equilibrium unemployment. They explained the long duration of shocks to unemployment by distinguishing between insiders and outsiders in the wage bargaining process. Ball (2009) presents evidence that NAIRU remains strongly history-dependent.
We are concerned here simply with the arrival of data for later dates, and ignore revisions to existing data. Again, although the derived estimates are artificial, each model is assessed based on the same information.
The results on the output gap, for the United States and other countries where lengthy quarterly time series are available, are generally in accord with conventional intepretations of macroeconomic history.