The most appropriate model to estimate Lithuanian business cycle

Abstract

This paper reviews four methods of estimating the output gap in Lithuania, including Hodrick-Prescott (HP) filter, Prior-Consistent (PC) filter, production function model and a multivariate unobserved components models. Latent variables obtained using Kalman filter. All estimates of output gap show that the economy of Lithuania has been above it's potential level at the end of 2004. The Kalman filter output gap was less volatile, compare to other methods and only from smooth results of Kalman filter it was possible to identify Lithuanian economy business cycle. A long-run potential growth of the Lithuanian economy is estimated at 5.75 per cent. We could not prove that the Kalman filter reduced end-of-sample uncertainty. Kalman filter was always underestimating the output gap, but HP filter tended to overestimate.