The Negative Mean Output Gap

Shekhar Aiyar and Simon Voigts

No 2019/183, IMF Working Papers from International Monetary Fund

Abstract: We argue that in an economy with downward nominal wage rigidity, the output gap is negative on average. Because it is more difficult to cut wages than to increase them, firms reduce employment more during downturns than they increase employment during expansions. This is demonstrated in a simple New Keynesian model with asymmetric wage adjustment costs. Using the model's output gap as a benchmark, we further show that common output gap estimation methods exhibit a systematic bias because they assume a zero mean. The bias is especially large in deep recessions when potential output tends to be most severely underestimated.

Keywords: WP; mean output gap; standard deviation; time series; Output gap estimation; business cycles; fiscal policy; monetary policy; output gap estimate; adjustment cost; nominal wage rigidity; output gap concept; output gap filter; output gap definition; Output gap; Potential output; Wage adjustments; Wage rigidity; Sticky prices; Global (search for similar items in EconPapers)
Pages: 24
Date: 2019-08-23
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Citations: View citations in EconPapers (7)

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