Estimating Production Gap and NAIRU in Iran's Economy by Using State-Space Model

Abstract

T he purpose of this paper is to estimate the output gap and NAIRU for Iran's economy, both of which are among the most important variables in determining the economic status. Since these variables are unobservable, to estimate them, one needs modern econometric techniques rather than conventional tools. For this reason, this paper uses the Kalman filter tool in the form of a state-space model. Since there are several different specifications for a state-space structure, seven different models are tested by using seasonal data from 1989 to 2014. Results show that only two specifications have suitable estimation results. The first one is a structural model consisting of output and unemployment rate decomposition, plus the relationship between the inflation rate and the output gap in the form of the Phillips curve, and the second is a system that only includes unemployment rate decomposition. The early model can show the periods of inflationary recession between 1992 and 1995, and a severe economic recession during the period of 2010–2013 due to economic sanctions imposed on Iran. The latter model can depict NAIRU gap fluctuations following the inflation fluctuations. In addition to the compatibility of these results with what is observed in reality, the parameters are also statistically significant.