Estimation of Output Gap and NAIRU in Iranian Economy Using the State Space Model


1 Department of Economics, Ferdowsi University of Mashhad, Khorasan-e-razavi, Iran.

2 Department of Economics, University of Tehran, Tehran, Iran.


The purpose of this paper is to estimate the output gap and NAIRU for Iran economy, both which are among the most important variables in determining the economy status. Since these variables are unobservable, to estimate them, one needs modern econometric techniques rather than conventional tools. For this reason, this paper uses the Kalman filter tool in the form of a state space model. Since there are several different specifications for a state space structure, seven different models are tested by using seasonal data from 1989 to 2014. Results show that only two specifications have suitable estimation results. The first one is a structural model consisting of output and unemployment rate decomposition, plus the relationship between the inflation rate and the output gap in the form of Phillips curve, and the second is a system that only includes unemployment rate decomposition. The early model can show the periods of inflationary recession during the period of 1992–1995, and severe economic recession during the period of 2010–2013 due to economic sanctions imposed on Iran. The latter model is able to depict NAIRU gap fluctuations in accordance with the inflation fluctuations. In addition to the compatibility of these results with what is observed in reality, the parameters are also statistically significant.