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The output gap is defined as actual minus potential output, in percent of the latter. For a more complete overview of the various methods, see Cerra and Saxena (2000).
The unemployment gap is defined as the actual unemployment rate (in percent) minus the NAIRU. All methods are estimated for the period 1970–99.
A Cobb-Douglas production function was used. While adding to the understanding of the factors underlying potential output, this method shifts the issue of assessing trends from overall output to the individual arguments of the production function. In particular, the NAIRU, and a view of normal capacity utilization (or total factor productivity) are crucial. Bolt and van Els (2000) compute output gaps in a similar manner, but using a CES production function) for 13 OECD countries.
For this method, wage inflation is assumed to be proportional to the difference between actual unemployment and the NAIRU (or, more accurately, the non-accelerating wage rate of unemployment, NAWRU). Here, wage inflation is defined as contractual wage growth, unless otherwise indicated.
The well-known problems related to the Hodrick-Prescott filter include the end-of-sample bias and the arbitrary choice of the detrending parameter. In this paper, using annual data, this parameter was set at 100, unless otherwise indicated.
In the model, unions’ bargaining power increases with a drop in unemployment, a rise in the replacement rate, and higher taxes (as this renders nontaxed activities more attractive in relative terms). Labor demand—and thus employment—declines as wage costs rise relative to the user cost of capital. See Broer, Draper, and Huizinga (1999).
In response to demands for higher wages the government threatened to prohibit any raise in contractual wages in 1994, but a voluntary wage agreement by social partners rendered this measure superfluous.
The latest published central bank projections date from December 1999. In line with other forecasts at the time, it includes growth of 3.0 percent in 2000 and 3.2 percent in 2001.
In each of the three models, short-run responses are driven by demand impulses, with wages and prices responding to the gap between demand and supply. In the OEF model, output cycles around a given trend with a rapid feedback, within 3-5 years. By contrast, in the central bank model, the medium-term path is not anchored by well-determined capacity constraints; while demand shocks eventually die out, they can have a significant lasting effect on the level of output. This feature makes the model less suitable for longer-run simulations. See van Els and Vlaar (1996).
Simulations with the models used here do not permit a derivation of the implicit weights of a monetary conditions index for the Netherlands. Specification of shocks to the exchange rate and interest rates in real terms is not feasible, and the exchange rate shock had to be modeled as a euro-area wide shock.
A remarkable feature of the OEF simulation is the drawn-out negative effect of a euro depreciation on the Dutch current account—compared to a regular, short-lived J-curve in the central bank's exercise. For the euro area as a whole, however, the OEF model also generates a regular J-curve.