@article{Consequences:663,
      recid = {663},
      author = {Laxton, Douglas and Shoom, Kevin and Tetlow, Robert},
      title = {Should the Change in the Gap Appear in the Phillips Curve?  Some Consequences of Mismeasuring Potential Output},
      publisher = {Bank of Canada},
      address = {1992},
      pages = {1 online resource (11 pages)},
      abstract = {In an economy where both supply and demand shocks are at  work, there will be considerable uncertainty associated  with any estimates of potential output and the natural rate  of unemployment. Laxton and Tetlow have shown that the  detrending techniques that have been used in the past to  provide estimates of excess demand conditions are likely to  suffer from measurement errors that persist over time. This  paper reports Monte Carlo evidence that suggests that such  errors in measuring the extent of excess demand can result  in significantly biased estimates of the coefficients of  Phillips curves and incorrect inferences in hypothesis  tests. In particular, it is shown that tests of whether or  not the change in the level of excess demand contributes to  the explanation of inflation via a Phillips curve are  likely to lead to incorrect conclusions. For the type of  Phillips curve considered in this paper, the estimated  effect on inflation of the level of excess demand tends to  be too small and the estimated effect of the change of  excess demand tends to be too large. It is shown that  researchers using standard techniques would often falsely  conclude that the change term was necessary to explain the  data, when in fact there was no such effect. It is noted  that this is likely to lead to overestimates of the degree  of hysteresis in output and hence of the output costs of  reducing inflation. The Monte Carlo experiments are carried  out using an unobserved components model of output,  structured and calibrated to reflect Canadian data. The  results appear to be robust to a variety of changes in the  assumptions.},
      url = {http://www.oar-rao.bank-banque-canada.ca/record/663},
      doi = {https://doi.org/10.34989/swp-1992-1},
}