Output Gap Estimation and Monetary Policy in China

Using the Bayesian multivariate Beveridge-Nelson decomposition method, this paper estimates China's output gap based on a multivariate dynamic model featuring distinct interactions among real output, inflation, money, and the exchange rate in China during the period 1980-2010. The authors compare the statistical nature and potential forecasting effects of the resulting multivariate gap measure on monetary policy with those of the output gap measures based on univariate models. The empirical results show that only the measure based on the multivariate system significantly predicts monetary policy, which indicates that the output gap estimated by the multivariate system contains more information than the traditional measures for macroeconomic policy adjustments do.