A NEW MEASURE OF US POTENTIAL OUTPUT, INFLATION FORECASTS, AND MONETARY POLICY RULES

This paper proposes a new measure of potential output for the USA. The key idea is that potential output is constructed as the level of output which would correspond to a forecast of no inflation change over the policy horizon. The resultant output gap has a clear interpretation as a measure to gauge future inflationary pressures. It also exhibits better predictability for future inflation changes in comparison with previous output gap measures. Simulation results further demonstrate its usefulness as a feedback variable in the Taylor monetary policy rule for interest rates. Copyright © 2009 The Authors. Journal compilation © 2009 Blackwell Publishing Ltd and The University of Manchester.