Working Paper Revision

Time-varying Uncertainty of the Federal Reserve’s Output Gap Estimate

Abstract: A factor stochastic volatility model estimates the common component to estimates of the output gap produced by the staff of the Federal Reserve, its time-varying volatility, and time-varying, horizon-specific forecast uncertainty. Output gap estimates are very uncertain, even well after the fact, especially at business cycle turning points. However, the common component of the output gap estimates is clearly procyclical, and innovations to the common factor produce persistent positive effects on economic activity. Output gaps estimated by the Congressional Budget Office have very similar properties. Increased macroeconomic uncertainty, as measured by the common factor's volatility, leads to persistent negative responses in economic variables.

Keywords: Output gap estimation; Unobserved variables; Real-time data; Factor model; Stochastic volatility; Macroeconomic uncertainty;

JEL Classification: E32; C53;

https://doi.org/10.17016/FEDS.2020.012r1

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2021-04-14

Number: 2020-012r1

Related Works

• Working Paper Revision: Time-varying Uncertainty of the Federal Reserve’s Output Gap Estimate