We emphasise that the evolution of inflation should be an important guiding principle in designing a well-performing measure of excess capacity in the economy, which is not directly
observable. Our framework is very flexible, transparent, and agnostic. It is an indirect measurement exercise – proceeding from observable quantity (inflation gap) to an unobservable one, to an inflation-relevant output. Crucially, the frequency-domain nature of our analysis enables us to find out at what frequency output and inflation comove. Other approaches commonly determine a measure of an ‘output gap’ with little or without reference to inflation and relate the headline CPI inflation to such an arbitrary measure using simple, but very restrictive,
regression analysis.