Employing the extended Kalman filter in measuring the output gap

Abstract

The paper has two parts. In the first part, the output gap and potential output series for the Turkish economy are derived within the context of a non-linear state space model, where the extended Kalman filter emerges as the estimation methodology. Such a methodology allows for time-varying parameters to decompose output into trend and cyclical components. The results imply that both the parameters in the model and the derived series are fairly reasonable and consistent with the path that the Turkish economy followed in the last fifteen years. In the second part, the relation between inflation and the output gap is analyzed. It is found that inflation and the output gap are not positively associated, contradicting studies that view demand side forces as the primary determinants of inflation in Turkey. © 2004 Elsevier B.V. All rights reserved.