What is the output gap? There are many definitions in the economics literature,all of which have a long history. I discuss three alternatives: the deviation ofoutput from its long-run stochastic trend (i.e., the “Beveridge-Nelson cycle”);the deviation of output from the level consistent with current technologies and normal utilization of capital and labor input (i.e., the “production-function approach”); and the deviation of output from “flexible-price” output (i.e., its“natural rate”). Estimates of each concept are presented from a dynamic-stochastic-general-equilibrium (DSGE) model of the U.S. economy used at theFederal Reserve Board. Four points are emphasized: The DSGE model’s es-timate of the Beveridge-Nelson gap is very similar to gaps from policy in-stitutions, but the DSGE model’s estimate of potential growth has a higher variance and substantially different covariance with GDP growth; the natural rate concept depends strongly on model assumptions and is not designed toguide nominal interest rate movements in “Taylor” rules in the same way asthe other measures; the natural rate and production function trends converge tothe Beveridge-Nelson trend; and the DSGE model’s estimate of the Beveridge-Nelson gap is as closely related to unemployment fluctuations as those frompolicy institutions and has more predictive ability for inflation.
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