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Estimates of potential output and the neutral short-term interest rate play important roles in policy making. However, such estimates are associated with significant uncertainty and subject to significant revisions. This paper extends the structural multivariate filter methodology by adding a monetary policy block, which allows estimating the neutral rate of interest for the U.S. economy. The addition of the monetary policy block further improves the reliability of the structural multivariate filter.

Banks and Banking --- Inflation --- Money and Monetary Policy --- Production and Operations Management --- Model Construction and Estimation --- Price Level --- Deflation --- Monetary Policy --- Macroeconomics: Production --- Interest Rates: Determination, Term Structure, and Effects --- Macroeconomics --- Monetary economics --- Finance --- Output gap --- Potential output --- Inflation targeting --- Real interest rates --- Production --- Prices --- Capacity utilization --- Monetary policy --- Economic theory --- Interest rates --- Industrial capacity --- United States

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This paper extends the multivariate filter approach of estimating potential output developed by Alichi and others (2018) to incorporate labor market hysteresis. This extension captures the idea that long and deep recessions (expansions) cause persistent damage (improvement) to the labor market, thereby reducing (increasing) potential output. Applying the model to U.S. data results in significantly smaller estimates of output gaps, and higher estimates of the NAIRU, after the global financial crisis, compared to estimates without hysteresis. The smaller output gaps partly explain the absence of persistent deflation despite the slow recovery during 2010-2017. Going forward, if strong growth performance continues well beyond 2018, hysteresis is expected to result in a structural improvement in growth and employment.

Inflation --- Labor --- Production and Operations Management --- Model Construction and Estimation --- Price Level --- Deflation --- Monetary Policy --- Macroeconomics: Production --- Demand and Supply of Labor: General --- Unemployment: Models, Duration, Incidence, and Job Search --- Macroeconomics --- Labour --- income economics --- Output gap --- Labor markets --- Potential output --- Unemployment rate --- Production --- Prices --- Economic theory --- Labor market --- Unemployment --- United States --- Income economics