Jelle Barkema, Tryggvi Gudmundsson, Mico Mrkaic, 06 December 2020

Output gaps remain a popular metric for assessing the stance of countries’ business cycles. However, their usefulness for real-time policymaking is disputed due to the challenges in estimating potential output. This column studies the use of output gaps in IMF surveillance work and finds that output gap measures are skewed to the downside, often revised, and only slightly correlated with other indicators of slack. Furthermore, text analysis finds a limited connection between the size of the output gap and policy recommendations. Taken together, these results suggest caution in using output gap estimates for policymaking during the Covid-19 recovery.

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