Estimating NAIRU for Turkey Using Extended Kalman Filter Approach

This paper estimates NAIRU (Non-Accelerating Inflation Rate of Unemployment) for the Turkish economy by systems approach, which includes an Okun-type relationship between output gap and unemployment gap, a Phillips curve equation, stochastic laws of motion for NAIRU and potential output and time-varying parameters. However, the requirement to simultaneously estimate parameters and to solve the state space problem introduces nonlinearity, which can be handled by Extended Kalman Filter (EKF). Estimation results suggest that NAIRU moves in tandem with the actual unemployment, yet following a more volatile path than the latter. Accordingly, the NAIRU series reacts more sharply to the crises than the actual unemployment. Furthermore, all of the derived series are plausible and capture the significant turning points of the economy. Meanwhile, the time-varying parameters indicate a stable, yet quite a weak link between unemployment and inflation, and a weakening, but significant pass-through to inflation. Moreover, the parameters also imply considerable inertia.