Nigeria’s Potential Growth and Output Gap: Application of Different Econometrics Filters

Abstract

The concept of potential output and the corresponding output gap had received considerable attention by both policy makers and academic researchers, particularly in the developed countries. This is a reflection of not only its theoretical significance, but also its policy relevance. Output gap is used to model price and wage inflation, in estimating fiscal balance and the impact of structural reforms on the economy, hence an important indicator of fiscal policy trust. Most importantly, to a central banker it is critical in modelling monetary policy decision making process, as it serves as an input into central banks economic projections which forms an integral part of monetary policy decision and the setting of monetary policy rates. This paper measures the potential output and the corresponding output gap for Nigeria using Hodrick-Prescott filter, Baxter-King filter and both fixed and full length Christiano-Fitzgerald filters. The methods yielded different results, but with strong similarities in their evolution over time. According to all the methods, on the average, the economy was over heated during the early part of the sample period (2004:Q1 to 2005:Q4) but operated below capacity between 2008:Q1 and 2009:Q4. Interestingly, a fairly strong and stable relationship exists between inflation and the estimated output gaps. With this noticeable connection, using output gap to compliment expert judgement, in monetary policy decision making, would conceptually be a good decision.

Keywords: Potential growth, output gap, econometric filtering, Nigeria