Measuring Potential Growth with an Estimated DSGE Model of Japan's Economy

In this paper, we calculate the potential output and the output gap using a Bayesian-estimated DSGE model of Japan's economy. The model is a two-sector growth model that takes into account growth rate shocks including investment-goods sector-specific technological progress. For bridging the gap with conventional measures, we define our measure of potential output as a component of the efficient output generated only by growth rate shocks. Our potential growth displays a high degree of smoothness and moves closely with conventional measures. Moreover, the output gap from our measure of potential output has forecasting power for inflation. We analyze the sensitivity of our measure to the specifications of monetary policy rules, labor supply shocks, price and wage markup shocks, and technology shocks as well as the robustness with respect to data revisions and updates.