A Systemic Approach to Estimating the Output Gap for the Italian Economy

Abstract

Estimating potential output and the corresponding output gap plays a key role, not only for inflation forecasting and the assessment of the economic cycle, but also for the fiscal governance of the European Union (EU). Potential output is, however, an unobservable and extremely uncertain variable. Empirical measurements differ considerably depending on the econometric approach adopted, the specification of the data generating process and the dataset used. The method adopted at the EU level, which was agreed within the Output Gap Working Group, has been subject to considerable debate. The fiscal councils of the various Member States contribute to the discussion over the output gap modelling. This paper aims at estimating the potential output of the Italian economy, using a combination of five different models proposed by the relevant literature. More specifically, in addition to a statistical filter, we use unobserved components models based on the Phillips curve, the Okun law and the production function. The approach adopted allows to reconcile the parsimony of the econometric specification with the economic interpretation of the results. Estimates of the output gap obtained with the five selected models present important properties: low pro-cyclicity, stability with respect to the preliminary data and consistency with the economic theory. The use of multiple models also enables the construction of confidence bands for the output gap estimates, which are helpful for policy analysis. In the empirical application for Italy, estimates and forecasts of the output gap recently produced by relevant organisations tend to fall within the confidence interval calculated on the basis of the five selected models.