The Negative Mean Output Gap

August 23, 2019

Preview Citation

Format: Chicago

Shekhar Aiyar, and Simon Voigts. The Negative Mean Output Gap, (USA: International Monetary Fund, 2019) accessed December 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We argue that in an economy with downward nominal wage rigidity, the output gap is negative on average. Because it is more difficult to cut wages than to increase them, firms reduce employment more during downturns than they increase employment during expansions. This is demonstrated in a simple New Keynesian model with asymmetric wage adjustment costs. Using the model's output gap as a benchmark, we further show that common output gap estimation methods exhibit a systematic bias because they assume a zero mean. The bias is especially large in deep recessions when potential output tends to be most severely underestimated.

Subject: Labor, Output gap, Potential output, Prices, Production, Sticky prices, Wage adjustments, Wage rigidity

Keywords: Adjustment cost, Business cycles, Fiscal policy, Global, Mean output gap, Monetary policy, Nominal wage rigidity, Output gap, Output gap concept, Output gap definition, Output gap estimate, Output gap estimation, Output gap filter, Potential output, Standard deviation, Sticky prices, Time series, Wage adjustments, Wage rigidity, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/183
Stock No:

WPIEA2019183
ISBN:

9781513511740
ISSN:

1018-5941

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