Working Paper

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

Abstract: What is the output gap and when do we know it? A factor stochastic volatility model estimates the common component to forecasts of the output gap produced by the staff of the Federal Reserve, its time-varying volatility, and time-varying, horizon-specific forecast uncertainty. The common factor to these forecasts is highly procyclical, and unexpected increases to the common factor are associated with persistent responses in other macroeconomic variables. However, output gap estimates are very uncertain, even well after the fact. Output gap uncertainty increases around business cycle turning points. Lastly, increased macroeconomic uncertainty, as measured by the output gap's time-varying volatility, produces pronounced negative responses to other macroeconomic variables.

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

JEL Classification: C53; E32;

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

Bibliographic Information

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

Part of Series: Finance and Economics Discussion Series

Publication Date: 2020-02-03

Number: 2020-012

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