Measuring Nigeria’s output gap: An application of Kalman filter

The deviation between an economy’s estimated potential output and its actual level of output is known as the output gap. The goal of assessing the output gap is to determine the scope or limit for long-term non-inflationary growth and to assess policymakers’ opinions on macroeconomic policies. Using the state-space model and Kalman filtering, the study used seasonally adjusted quarterly and annual GDP data from Nigeria. In order to state the predictability of output, the paper extended the univariate model to a multivariate model. However, we used the univariate Hodrick-Prescott (HP) filter as a baseline for comparing the output gap. The result shows that the gap size varies depending on the approach applied. As a result, the model shows that inflation outperforms unemployment as the quantitative measure of Nigeria’s output gap. The results were satisfactory, and the univariate unobserved component utilizing the Kalman filter, surprisingly, yielded significant outcomes toward the output gap. The output gap estimation also reveals sensitivity due to the inclusion of unemployment in the quarterly data. This implies that policymakers should avoid depending on one approach of estimating output gap.