The estimates of output gap, as a measure of overall amount of slack in the economy, play an important role in policy decisions related to inflationary pressures and fiscal sustainability. However, its unobserved nature and inherent uncertainty make output gaps difficult to measure accurately, especially in real-time. The paper studies revisions’ properties and determinants of the real-time output gap estimates for the Euro Area countries, based on the IMF WEO vintages over the period 1994-2017. We find that real-time output gap estimates tend to have sizable and statistically significant negative averages (implying that the economies grow below potential on average), that are revised away in later vintages. We show that most of the large output gap revisions can be explained (i) by the difficulty to predict recessions (forecast errors) and (ii) by over-optimism about potential output (judgment). Our findings suggest that structural fiscal deficits are under-estimated in real time, especially for countries with high public debt. Fiscal policy recommendations thus can be too lenient with the benefit of hindsight. Inflation-targeting monetary policy setting appears to be less affected as real-time inflation is not significantly associated with real-time output gaps. We discuss possible options to improve the real-time output gap estimates, including a concept of sustainable (as an alternative to potential) output.
