Working Paper no. 148
By Edward Nelson and Kalin Nikolov
Understanding the degree of measurement error in the estimates of the output gap available to policy-makers in ‘real time’ is important both for the formulation of monetary policy and for the study of inflation behaviour. For the United Kingdom, no official output gap series exists, but an approximate series can be deduced from analysis of statistical releases and policy-makers’ statements. On this basis, we construct a real-time UK output gap series beginning in 1965 and are therefore able to obtain estimates of the extent of real-time output gap mismeasurement in the 1970s and 1980s. We find that monetary policy errors due to output gap mismeasurement contributed approximately 3.0 to 7.1 percentage points to average UK inflation in the 1970s and 0.7 to 5.5 percentage points to inflation in the 1980s.