5.3 The unemployment gap and the output gap
Figure 7 shows the estimate of the NAIRU from the model. The NAIRU is estimated to be in the range of 6.4%-6.8% for the period of 1994-1998. Since then the NAIRU has declined steadily and reached a trough of 4.8% by the end of 2004. This finding is consistent with the previous work of Guy and Szeto (2004) who estimated the NAIRU over the period 1988q3 to 2003q4 using a Kalman filter on a reduced form approach. Based on the SMM estimates, the GFC may have caused the NAIRU to drift upwards to 5.6% at end of the sample period with a 95% confidence interval of 4.7% to 6.6%.
It is interesting to note that according to the HP filter, the NAIRU is estimated to be around 7% at the end of the sample period. Based on the HP filter, there is no spare capacity in the labour market, which is consistent with a positive HP filter output gap. However, the result of no slack in the labour market is definitely at odds with our perceptions and understanding of the economy - both inflation and wage outturns are still weak.
Finally, we assess the relationship between the estimated unemployment gap of the model and the production cycle as measured by the output gap by computing the cross-correlation of coefficients. The table below indicates that there is a very strong relationship between the unemployment gap and the output gap. The results are also supported by Figure 8, which compares the estimated output gap with the estimated unemployment gap.
- Figure 7 - the time-varying NAIRU with its 95% confidence interval
- Figure 8 - Unemployment gap and SMM output gap
| Lag j | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| -8 | -4 | -3 | -2 | -1 | 0 | 1 | 2 | 3 | 4 | 8 | |
| SMM Output gap | 0.09 | 0.42 | 0.52 | 0.63 | 0.73 | 0.83 | 0.89 | 0.88 | 0.84 | 0.75 | 0.30 |
