The information content of capacity utilization for detrending total factor productivity

In the production function approach, an accurate output gap assessment requires a careful evaluation of the total factor productivity (TFP) cycle. We build a common cycle model that links TFP to capacity utilization and we show that, in almost all of the pre-enlargement EU countries, using information about capacity utilization reduces both the total estimation error and the revisions in real-time estimates of the concurrent TFP cycle compared to a univariate decomposition. We also argue that relaxing the constant drift hypothesis in favour of a non-linear specification helps to offset a general tendency to underestimate the TFP cycle in the last decade.