Estimating the New Keynesian Output Gap for Armenia via a Bayesian Approach

As the New Keynesian output gap cannot be observed in practice, there is quite some debate on what this variable actually looks like. Rather than taking the standard approach of using a time trend or the HP-filter to estimate it, this paper separates trend from cycle via Bayesian estimation of a New Keynesian model, augmented with an unobserved components model for output. This provides us with a model-consistent estimate of the output gap. This estimate is compared with popular proxies used in the literature. It turns out that the benefits of using the model-based approach mainly lie in real time. Model coefficients are easily interpretable, and the output gap series is consistent with a broader analysis of Armenian economic developments.