Visualizing the invisible: estimating the New Keynesian output gap via a Bayesian approach

As both the natural level of output and the New Keynesian output gap
are unobserved, there is quite some debate on the question how these variables
look like in practice. Rather than taking the standard approach of using a time
trend or the HP-filter to obtain estimates of these two objects, this paper takes
a theoretically more sound route by separating trend from cycle via Bayesian
estimation of a New Keynesian model, augmented with an unobserved com-
ponents model for output. This delivers us with model consistent estimates of
both the natural level of output and the New Keynesian output gap. These
estimates are then compared with the dominant output gap proxies used in the
literature. It turns out that the benefits of using the model-based approach
taken in this paper mainly emerge in real time, thereby making this method
potentially useful for the conduct of monetary policy.

Key words: Bayesian estimation; unobserved components model; New Key-
nesian model; output gap; New Keynesian Phillips curve

JEL-classifications: C53, E32, E37, E52