The assessment of potential output and the output gap holds significant im-portance for policymakers, as it serves as a cornerstone for maintaining macroeconomic stability encompassing aspects such as real GDP growth, price stability, and full employment. This study investigates various meth-odologies employed to estimate potential output and the output gap in Rwanda, utilizing seasonally adjusted quarterly data spanning from 2006Q1 to 2021Q4. Initially, we explore mechanical or statistical approaches includ-ing Hodrick-Prescott, linear time trend, Beveridge Nelson decomposition, and unobserved component model. Additionally, a multivariate approach, specifically the production function approach, is employed. Diagnostic eval-uations, such as assessing Granger causality between the output gap and in-flation, are conducted using Rwandan data from 2006 Q1 to 2021 Q4 to dis-cern potential linkages. The findings across different methodologies suggest that the output gap fluctuates within a range of ？6 to 6 during normal condi-tions; the primary implication underscores the necessity for fiscal and mon-etary policies to respond to positive and negative output gaps, respectively, thereby mitigating inflationary pressures and recessionary periods while fostering sustained economic growth. The study investigates the correlation between the output gap and inflation, revealing a robust causal relationship between the two factors in the Rwandan economy.
Cite this paper
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