Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

Abstract: I study potentials and gaps, permanent and transitory fluctuations in macroeconomic variables using the Smets and Wouter (2007) model. Model-based gaps display low frequency variations; possess more than business cycle fluctuations; have similar frequency representation as potentials, and are correlated with them. Permanent and transitory fluctuations display similar features, but are uncorrelated. I use a number of filters to extract trends and cycles using simulated data. Gaps are best approximated with a polynomial filter; transitory fluctuations with a differencing approach, but distortions are large. Explanations for the results are given. I propose a filter which reduces the biases of existing procedures.

Keywords: Gaps and potentials; permanent and transitory components; filtering; cyclical fluctuations; gain functions

JEL-codes: C31; E27; E32

70 pages, January 1, 2020

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