Universidad de Valencia uv_anim.gif (52696 bytes)
Rafael Domenech xano.jpg (3336 bytes)


   October 24, 2005

Facultad de Economia, 46022 Valencia, Spain   

   Estimating Potential Output, Core Inflation and the Nairu as Latent Variables

Rafael Domenech and Victor Gomez

This paper proposes a new method to obtain estimates of the NAIRU, the core inflation and the investment rate trend for the United States using an unobserved components model which is compatible with the usual decomposition of real gross domestic product into trend and cycle. The model includes a standard Okun's law, a forward-looking Phillips curve and an investment equation. The unknown parameters in the model are estimated by maximum likelihood using a Kalman filter initialized with a partially diffuse prior, and the unobserved components are estimated using a smoothing algorithm. Our results show that the output gap is positively correlated with the deviations of the investment rate from its trend and the inflation rate from core inflation, and negatively correlated with the deviations of the unemployment rate from the NAIRU.

Paper (pdf)  Data and Matlab codes (zip)