The Bank of Canada's New Quarterly Projection Model, Part 4. A Semi-Structural Method to Estimate Potential Output: Combining Economic Theory with a Time-Series Filter
The level of potential output plays a central role in the Bank of Canada's new Quarterly Projection Model (QPM). This report, the fourth in a series documenting QPM, describes a general method to measure potential output, as well as its implementation in the QPM system. The report begins with a short history of the measurement of potential output. Building on this experience, a hybrid method of measuring potential output is developed that combines economic structure with a time-series filter. The resulting filter, known as the extended multivariate (EMV) filter, exploits theoretical relationships that are embodied in QPM in an effort to identify demand-side and supply-side influences on output. These various relationships are combined in a filter that imposes a smoothness property on the dynamics of potential output. This report describes the general structure of the EMV filter, the various economic relationships that it uses, and the weights applied to these different pieces of information. The report concludes with an evaluation of the EMV filter and some suggestions for future improvements.