A new production function estimate of the euro area output gap

Abstract

Abstract We develop a new version of the production function (PF) approach for estimating the output gap of the euro area. Assuming a CES (constant elasticity of substitution) technology, our model does not call for any (often imprecise) measure of the capital stock and improves the estimation of the trend total factor productivity using a multivariate unobserved components model. With real‐time data, we assess this approach by comparing it with the Hodrick–Prescott (HP) filter and with a Cobb–Douglas PF approach with common cycle and implemented with a multivariate unobserved components model. Our new PF estimate appears highly concordant with the reference chronology of turning points and has better real‐time properties than the univariate HP filter for sufficiently long time horizons. Its inflation forecasting power appears, like the other multivariate approach, less favourable than the statistical univariate method. Copyright © 2009 John Wiley & Sons, Ltd.