The Euro-Area Output Gap through the Lens of a DSGE Model

Abstract

The paper provides estimates of the euro-area output gap, based on a relatively standard medium scale DSGE model estimated recursively with Bayesian techniques over the period 1985-2016. The main findings can be summarized as follows. First, our measure of output gap identifies episodes of expansion and recession generally in line with the official business cycle dating of the CEPR. Second, unlike measures of output gap obtained by means of statistical filtering techniques, real-time DSGE-based estimates are remarkably stable and hence are less prone to ex-post revisions. According to our results, the euro-area output gap was -3.4% in 2016, more negative than assessed by most economic analysts and institutions (spanning a range between from 0 and to -2%), but arguably more consistent with the still weak dynamics of both labour costs and core inflation.