The first discussion paper of the year has been published on the Reserve Bank’s website.
Gunes Kamber, James Morley and Benjamin Wong write on
Intuitive and Reliable Estimates of the Output Gap from a Beveridge-Nelson Filter
Non-technical summary of DP2017/1
The Beveridge-Nelson (BN) trend-cycle decomposition based on autoregressive forecasting models of U.S. quarterly real
GDP growth produces estimates of the output gap that are strongly at odds with widely-held beliefs about the amplitude,
persistence, and even sign of transitory movements in economic activity. These antithetical attributes are related to
the autoregressive coefficient estimates implying a very high signal-to-noise ratio in terms of the variance of trend
shocks as a fraction of the overall quarterly forecast error variance. When we impose a lower signal-to-noise ratio, the
resulting BN decomposition, which we label the "BN filter", produces a more intuitive estimate of the output gap that is
large in amplitude, highly persistent, and typically increases in expansions and decreases in recessions. Real-time
estimates from the BN filter are also reliable in the sense that they are subject to smaller revisions and predict
future output growth and inflation better than estimates from other methods of trend-cycle decomposition that also
impose a low signal-to-noise ratio, including deterministic detrending, the Hodrick-Prescott filter, and the bandpass
filter.
The paper: dp1701.pdf