Nowcasting the output gap

Abstract

We propose a way to directly nowcast the output gap using the Beveridge–Nelson decomposition based on a mixed-frequency Bayesian VAR. The mixed-frequency approach produces similar but more timely estimates of the U.S. output gap compared to those based on a quarterly model, the CBO measure of potential, or the HP filter. We find that within-quarter nowcasts for the output gap are more reliable than for output growth, with monthly indicators for a credit risk spread, consumer sentiment, and the unemployment rate providing particularly useful new information about the final estimate of the output gap. An out-of-sample analysis of the COVID-19 crisis anticipates the exceptionally large negative output gap of -8.3% in 2020Q2 before the release of real GDP data for the quarter, with both conditional and scenario nowcasts tracking a dramatic decline in the output gap given the April data.