Empirical Economics

, Volume 40, Issue 2, pp 521–536 | Cite as

Estimating Europe’s natural rates

Original Paper


This article estimates potential output, the natural rate of unemployment, and the core inflation rate using aggregated euro area data. The empirical model consists of a Phillips curve linking inflation to unemployment. An Okun-type relationship is used to link the output gap to cyclical unemployment. The model further accounts for new developments in unobserved component models by allowing (i) for correlation between shocks to the natural rates and the corresponding gaps and (ii) structural breaks in the drift of potential output and the natural rate of unemployment.


Natural rates Correlated unobserved components Kalman filter Structural breaks 


  1. Andrews DWK (1993) Tests for parameter instability and structural change with unknown change point. Econometrica 61(4):821–856. http://ideas.repec.org/a/ecm/emetrp/v61y1993i4p821-56.html Google Scholar
  2. Andrews DWK, Ploberger W (1994) Optimal tests when a nuisance parameter is present only under the alternative. Econometrica 62(6):1383–1414. http://ideas.repec.org/a/ecm/emetrp/v62y1994i6p1383-1414.html
  3. Apel M, Jansson P (1999a) System estimates of potential output and the nairu. Empir Econ 24(3): 373–388CrossRefGoogle Scholar
  4. Apel M, Jansson P (1999b) A theory-consistent system approach for estimating potential output and the nairu. Econ Lett 64(3): 271–275CrossRefGoogle Scholar
  5. Bai J, Perron P (1998) Estimating and testing linear models with multiple structural changes. Econometrica 66(1): 47–78CrossRefGoogle Scholar
  6. Bai J, Perron P (2003) Computation and analysis of multiple structural change models. J Appl Econom 18(1): 1–22CrossRefGoogle Scholar
  7. Bai J, Perron P (2006) Multiple structural changes models: a simulation analysis. In: Corbea D, Durlauf S, Hansen B.E. (eds) Econometric theory and practice: frontiers of analysis and applied research. Cambridge University Press, London, pp 212–237Google Scholar
  8. Basistha A (2007) Trend-cycle correlation, drift break and the estimation of trend and cycle in Canadian gdp. Can J Econ 40(2): 584–606CrossRefGoogle Scholar
  9. Basistha A, Nelson CR (2007) New measures of the output gap based on the forward-looking new keynesian phillips curve. J Monet Econ 54(2): 498–511CrossRefGoogle Scholar
  10. Berger T, Everaert G (2008) Unemployment persistence and the nairu: a Bayesian approach. Scott J Political Econ 55(3):281–299. http://ideas.repec.org/a/bla/scotjp/v55y2008i3p281-299.html Google Scholar
  11. Beveridge S, Nelson CR (1981) A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the ‘business cycle’. J Monet Econ 7(2): 151–174CrossRefGoogle Scholar
  12. Blanchard O, Summers L (1986) Hysteresis and the european unemployment problem. NBER Macroecon Annu 1: 15–77CrossRefGoogle Scholar
  13. Burns A, Mitchell W (1946) Measuring business cycles. NBER, New YorkGoogle Scholar
  14. Chow GC (1960) Tests of equality between sets of coefficients in two linear regressions. Econometrica 28(3):591–605. http://www.jstor.org/stable/1910133 Google Scholar
  15. Clark PK (1987) The cyclical component of U.S. economic activity. Q J Econ 102(4): 797–814CrossRefGoogle Scholar
  16. Clark PK (1989) Trend reversion in real output and unemployment. J Econom 40(1):15–32. http://ideas.repec.org/a/eee/econom/v40y1989i1p15-32.html Google Scholar
  17. Domenech R, Gomez V (2006) Estimating potential output, core inflation, and the nairu as latent variables. J Bus Econ Stat 24(3): 354–366CrossRefGoogle Scholar
  18. Durbin J, Koopman S (2001) Time series analysis by state space methods. Oxford University Press, New YorkGoogle Scholar
  19. Fabiani S, Mestre R (2004) A system approach for measuring the euro area NAIRU. Empir Econ 29: 311–341CrossRefGoogle Scholar
  20. Fagan G, Henry J, Mestre R (2005) An area–wide model (awm) for the euro area. Econ Model 22: 39–59CrossRefGoogle Scholar
  21. Friedman M (1968) The role of monetary policy. Am Econ Rev 58: 1–17Google Scholar
  22. Hansen BE (1997) Approximate asymptotic p values for structural-change tests. J Bus Econ Stat 15(1):60–67. http://ideas.repec.org/a/bes/jnlbes/v15y1997i1p60-67.html Google Scholar
  23. Harvey A (1985) Trends and cycles in macroeconomic time series. J Bus Econ Stat 3: 216–227CrossRefGoogle Scholar
  24. Harvey A (1989) Forecasting structural time series models and the Kalman filter. Cambridge University Press, CambridgeGoogle Scholar
  25. Kuttner KN (1994) Estimating potential output as a latent variable. J Bus Econ Stat 12(3):361–368. http://ideas.repec.org/a/bes/jnlbes/v12y1994i3p361-68.html Google Scholar
  26. Laubach T (2001) Measuring the nairu: evidence from seven economies. Rev Econ Stat 83(2): 218–231CrossRefGoogle Scholar
  27. Mesonnier JS, Renne JP (2007) A time-varying “natural” rate of interest for the euro area. Eur Econ Rev 51(7):1768–1784. http://ideas.repec.org/a/eee/eecrev/v51y2007i7p1768-1784.html Google Scholar
  28. Morley JC, Nelson CR, Zivot E (2003) Why are the beveridge-nelson and unobserved-components decompositions of gdp so different?. Rev Econ Stat 85(2): 235–243CrossRefGoogle Scholar
  29. Nelson CR, Lee J (2007) Expectation horizon and the phillips curve: the solution to an empirical puzzle. J Appl Econom 22(1): 161–178CrossRefGoogle Scholar
  30. Okun A (1970) The political economy of prosperity. The Brookings Institution, WashingtonGoogle Scholar
  31. Orlandi F, Pichelmann K (2000) Disentangling trend and cycle in the eur-11 unemployment series. An unobserved component modelling approach. European Economy—Economic Papers 140, Commission of the EC, Directorate-General for Economic and Financial Affairs (DG ECFIN)Google Scholar
  32. Perron P, Wada T (2005) Let’s take a break: trends and cycles in us real gdp? Working Papers Series WP2005-031, Boston University, Department of Economics. Available at http://ideas.repec.org/p/bos/wpaper/wp2005-031.html
  33. Phelps E (1968) Money-wage dynamics and labor market equilibrium. J Political Econ 76: 678–711CrossRefGoogle Scholar
  34. Proietti T, Musso A, Westermann T (2007) Estimating potential output and the output gap for the euro area: a model-based production function approach. Empir Econ 33: 85–113CrossRefGoogle Scholar
  35. Quandt RE (1960) Tests of the hypothesis that a linear regression system obeys two separate regimes. J Am Stat Assoc 55(290):324–330. http://www.jstor.org/stable/2281745 Google Scholar
  36. Rapach DE, Wohar ME (2005) Regime changes in international real interest rates: are they a monetary phenomenon?. J Money Credit Bank 37(5): 887–906CrossRefGoogle Scholar
  37. Roeger W (2006) The production function approach to calculating potential growth and output gaps. Estimates for eu member states and the US. Tech. Rep. Workshop on Perspectives on potential output and productivity growth, organised by Banque de France and Bank of Canada, April 24 and 25, 2006Google Scholar
  38. Ruenstler G (2002) The information content of real-time output gap estimates: an application to the euro area. Working Paper Series 182, European Central BankGoogle Scholar
  39. Watson MW (1986) Univariate detrending methods with stochastic trends. J Monet Econ 18(1): 49–75CrossRefGoogle Scholar

Copyright information

© Springer-Verlag 2010

Authors and Affiliations

  1. 1.University of Muenster and SHERPPAMuensterGermany

Personalised recommendations