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short essays and reports on the economic issues of the day
2004 ■ Number 2

Mind the Gap: Measuring Actual vs. Potential Output
Kevin L. Kliesen
he Organization for Economic Cooperation and
available to policymakers as of May 2001 (initial estimate of
Development recently forecasted that real U.S. GDP
first-quarter real GDP). The third measure uses the Hodrick(output) in 2004 will average 0.3 percent less than
Prescott (HP) technique, which measures the gap with the
potential output. In the third quarter of 2003, though, real GDP
current vintage of NIPA data (in 2000 dollars).
grew at a surprising 8.2 percent annual rate, the economy’s
From the chart, it is apparent that estimates of the output
fastest rate of growth in nearly 20 years. If real GDP has
gap can differ significantly across both estimation techniques
increased by 4 percent (annual rate) in the fourth quarter of
and data vintages. For example, in the first quarter of 2000,
2003, which many economists expect, then the economy will
the difference between the CBO estimate and the real-time
have grown at a 6.1 percent annual rate over the second half
BP estimate was 2 percent of potential GDP.
of 2003.
There are two key reasons why estimates of the gap should
Although few economists expect this growth rate to persist
be viewed cautiously. First, the output gap depends on a value
into 2004, it seems apparent that recent economic growth has
that can be measured with reasonable accuracy (real GDP) and
been boosted by expansive monetary and fiscal policies. Hence,
a value that cannot (potential output); moreover, there is no
an important question for policymakers is when will the peragreed upon method for calculating potential output. Second,
centage difference between the economy’s hypothesized level
actual GDP is continually revised to incorporate improved
of potential output and actual output—termed the output gap—
data or new methodologies. Hence, the current estimated gap
be closed? A highly expansionary monetary policy entails little
may look much different after a future revision that incorporisk of an acceleration of inflation when there is considerable
rates new information. ■
resource slack. But as the gap closes and the economy increases
Data are from the manuscript “The Reliability of Inflation Forecasts Based on
its use of resources, continuing such a policy carries significant
Output Gap Estimates in Real Time,” by Athanasios Orphanides and Simon van
Norden (November 2003).
risk of a rapid acceleration of inflation. Key to this
framework, though, is a correct measurement of
the gap. Thus, perhaps a more pertinent question is
GDP Output Gaps: How Reliable?
how accurate are measures of the output gap?
The chart plots three different measures of the
Percentage of Potential GDP
output gap using three different vintages of data.
The first measure is derived from the Congressional
Budget Office’s (CBO) measure of potential real GDP,
which is estimated from an econometric model.
This gap is measured in 1996 dollars, which are the
estimates prior to the Dec. 10, 2003, 12th comprehensive revision of the national income and product
accounts (NIPA).
The remaining two measures are derived from
two different statistical filtering (detrending) tech–2.00
CBO ($1996)
Band-Pass (Real Time)
H-P ($2000)
niques that extract the long-run component of real
GDP, which approximates potential output. The
first, using the band-pass (BP) technique, measures
NOTE: The H-P measure uses data after the Dec. 10, 2003, NIPA comprehensive revision. The other
the gap in “real time.”1 For example, the output gap
two measures use data prior to this revision.
for the first quarter of 2001 is calculated from data


Views expressed do not necessarily reflect official positions of the Federal Reserve System.