BIS paper defends credit gap measure
Use of Hodrick-Prescott filter is controversial but the gap still outperforms others, authors find
Economists from the Bank for International Settlements defend the methodological choices behind one of the institution’s key early-warning indicators in a new working paper.
The credit gap, which measures the deviation of credit-to-GDP ratios from their long-run trend, relies on the Hodrick-Prescott filter in its construction. HP filters are controversial for generating “spurious dynamics” – translating noisy data into a neat ‘trend’, which may nevertheless have little basis in reality.
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