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Suite as! Augmenting the Reserve Bank’s output gap indicator suite

Punnoose Jacob, Finn Robinson

The Reserve Bank uses an output gap indicator suite (OGIS) to help estimate the current degree of capacity pressure in the economy. When the output gap is positive, capacity pressures are high and the labour market is likely to be tight. As a consequence, inflation is likely to increase through the Phillips curve relationship. The output gap is hence very important for monetary policy.

Unlike GDP, we cannot directly measure the output gap and the estimates of the output gap obtained from statistical models tend to get revised as new datapoints are added. This is particularly true for estimates of the output gap at the endpoint of history. Using a wider range of indicators to assess capacity pressures reduces the degree to which the output gap needs to be revised.

This paper augments the existing suite with new indicators. It also evaluates how well each indicator explains inflation in a Phillips curve model, and how well it forecasts inflation and GDP. Overall, we find that the indicators perform well in these evaluations, which confirms that they are useful variables to look at when assessing capacity pressures in New Zealand.