An Exploration of Real-Time Revisions of Output Gap Estimates Across European Countries

TLDR: In this article, the authors analyzed real-time revisions in output gap estimates published by the European Commission for 15 countries over the period 2002-2014 and found that output gap revisions are mainly driven by GDP growth forecast errors.

Abstract: This document analyses real-time revisions in output gap estimates published by the European Commission for 15 countries over the period 2002-2014. We find that output gap revisions (both in levels and changes) are mainly driven by GDP growth forecast errors. Also, output gap revisions have opposite signs across expansions and recessions: real-time output gaps are downward biased (smaller than the final estimates) during expansions and upward biased (higher than the final estimates) in recessions. Our findings may have relevant implications for the conduct and assessment of fiscal policy in real time. For instance, according to our results, real-time estimates of the structural balance would be upward biased in expansions and downward biased in recessions. This implies that the fiscal stance of an economy estimated in real time would be excessively expansionary in recessions as compared to the final estimate. As a result, we argue that corrections to real-time estimates of the structural balance suggested in the literature should be contingent on the degree of slack in the economy.

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AN EXPLORATION OF REAL-TIME
REVISIONS OF OUTPUT GAP
ESTIMATES ACROSS EUROPEAN
COUNTRIES
Documentos Ocasionales
N.º 1605
Pablo Hernández de Cos, Aitor Lacuesta
and Enrique Moral-Benito
2016

AN EXPLORATION OF REAL-TIME REVISIONS OF OUTPUT GAP ESTIMATES
ACROSS EUROPEAN COUNTRIES

Documentos Ocasionales. N.º 1605
2016
Pablo Hernández de Cos, Aitor Lacuesta and Enrique Moral-Benito
BANCO DE ESPAÑA
AN EXPLORATION OF REAL-TIME REVISIONS OF OUTPUT GAP
ESTIMATES ACROSS EUROPEAN COUNTRIES

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ISSN: 1696-2230 (on line)

Abstract
This document analyses real-time revisions in output gap estimates published by the European
Commission for 15 countries over the period 2002-2014. We fi nd that output gap revisions
(both in levels and changes) are mainly driven by GDP growth forecast errors. Also, output
gap revisions have opposite signs across expansions and recessions: real-time output gaps
are downward biased (smaller than the fi nal estimates) during expansions and upward biased
(higher than the fi nal estimates) in recessions. Our fi ndings may have relevant implications for
the conduct and assessment of fi scal policy in real time. For instance, according to our results,
real-time estimates of the structural balance would be upward biased in expansions and
downward biased in recessions. This implies that the fi scal stance of an economy estimated in
real time would be excessively expansionary in recessions as compared to the fi nal estimate.
As a result, we argue that corrections to real-time estimates of the structural balance suggested
in the literature should be contingent on the degree of slack in the economy.
Keywords: Output-gaps, real-time data, fi scal policy.
JEL classifi cation: E32, E52, E60.

Frequently asked questions

Q1. what are the main conclusions from this literature?

The main conclusions from this literature are: 1) output gap estimates are subject to signifi cant revisions in terms of magnitude; 2) the real-time output gaps have a negative bias (real-time output gaps are smaller on average than fi nal estimates); 3) the revisions of output gaps are higher at cyclical turning points; 4) data revisions do not play a major role in the revisions of output gaps; 5) revisions seem to be more related to projected actual GDP numbers than to potential GDP, and the former are related to macroeconomic projections. 

Q2. How does the European Commission infer the output gap?

since potential GDP cannot be directly observed from economic data, the European Commission infers the output gap using a production function approach (see Havik et al., 2014). 

Q3. What is the main reason why the output gap estimates are often over-estimated?

In particular, it is often justifi ed that the lack of reliability of output gap estimates should lead to less weight being attributed to the concept of structural balances in respect of the fi scal rules that could be substituted for an expenditure rule in which the ceiling on public expenditure growth would be linked to the evolution of (past and future) GDP growth. 

Q4. What are the main implications of the output gap revisions?

The authors also show how revisions in output gaps can be decomposed into revisions in real GDP forecast errors, GDP data revisions and potential GDP, with forecast errors chiefl y responsible for the overall real-time revisions in output gaps and their cyclicality. 

Q5. What is the definition of asymmetric revisions?

The authors label as asymmetric those revisions that are positive in expansions and negative in recessions; according to this terminology, symmetric revisions would always be either positive or negative. 

Q6. what is the impact of a negative bias on real-time output gaps?

In particular, inthe case of the implications for fi scal policy, on which this paper focuses, if a negative bias on real-time output gaps is confi rmed, this would imply that structural fi scal balances estimated in real time would on average be overestimated (and structural fi scal defi cits underestimated), thus providing an optimistic view of the underlying fi scal position of countries. 

Q7. What is the main argument of Kempkes?

This fi nding casts doubt over the result by Kempkes (2014), who argues that resulting structural balances are always over-estimated in real time because output gaps are downward-biased in real time. 

Q8. What is the importance of the output gap for policy analysis?

Both levels and changes of output gaps can play an important role in the conduct of monetary policy as an indication of infl ationary pressures. 

Q9. What is the reason for the revisions of output gaps estimated in real time?

revisions of output gaps estimated in real time might be due to changes in the modelling techniques employed, which could be based on new theoretical or empirical fi ndings regarding the economy under consideration.