Unobserved Components Model(s): Output Gaps and Financial Cycles

Justine Guillochon and Julien Le Roux

Working papers from Banque de France

Abstract: The Global Financial Crisis highlighted the need for policymakers to consider the stage of the financial cycle to better evaluate the cyclical position of the economy when designing monetary policy decisions. If financial variables are omitted from the estimations of the output gap, a common and unobserved indicator of the business cycle, important financial or external imbalances that may lead to future recessions may not be captured. This paper presents a suite of estimates of output gaps incorporating financial variables. The estimates are based boThéon small unobserved components models and a large unobserved components model that follows a production function approach. The results show that exploiting the information content of financial variables, which co-move strongly with the output cycle, can sometimes improve the real-time estimates of the output gap. However, these improvements are of a limited magnitude and very sensitive to the choice of the chosen financial variables.

Keywords: Output Gap; Potential Output; Financial Cycle; Monetary Policy; Unobserved Components Model. (search for similar items in EconPapers)
JEL-codes: C32 E32 E44 E47 E52 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2023
New Economics Papers: this item is included in nep-eec, nep-ifn and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:926

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