Incorporating Financial Cycles in Output Gap Measures: Estimates for the Euro Area

Pau Rabanal and Marzie Sanjani
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Pau Rabanal: IMF
Marzie Sanjani: International Monetary Fund

No 426, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: During the early 2000s, the euro area periphery countries experienced a credit and house price boom, but with moderate CPI inflation. We suggest a new approach for analyzing the role of credit and house prices in potential output and estimating the output gap. We present a two-country DSGE model for the core and periphery of the euro area, with financial frictions at the household level. We use several macroeconomic variables, including house prices and household credit for each region, to estimate the model. We find that, in the core, the measure of output gap is independent of financial frictions and is similar to that obtained with the Hodrick and Prescott filter, because of the absence of a credit boom. On the contrary, in the periphery, the presence of financial frictions amplify economic fluctuations and the output gap. We also present evidence of the trade-offs faced by the European Central Bank when trying to stabilize two regions in a currency union with divergent economic cycles.

Date: 2015
New Economics Papers: this item is included in nep-dge, nep-eec, nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:426

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