Potential Output: Concepts and Measurement - Department of Labour

Darren Gibbs 95
estimates suggest that a negative output gap existed in March 1992, with the
more intuitively plausible yl1 measure suggesting that a negative output gap of
around 1.5 percent of GDP remained in the 1994 March quarter.
Capital input related approaches
Two techniques of relating solely capital inputs to output were applied. The first
approach, similar in nature to that used to derive yl1 above, was to relate
deviations in actual from potential output to deviations in capacity utilisation
from historical norms. The capacity utilisation series used was that collected in
the Quarterly Survey of Business Opinion (produced by the New Zealand
Institute of Economic Research).
The second approach used was the output/capital ratio approach discussed
in section 4 which relies on the assumption of a stable proportional relationship
between the stock of capital and potential output. Annual capital stock estimates
for the non-government sector (excluding dwellings) produced by the Research
Project on Economic Planning (Philpott, 1994) were interpolated to produce
quarterly capital stock estimates through to March 1993; and capital stock data
for the remaining year of the sample were estimated from SNA data with the
rate of depreciation set at 1.8% per quarter. 13
Figure 4 illustrates the estimated potential output series derived from applying
the above techniques (yk1 and yk2), and the corresponding output gaps.
As the figures illustrate, the two estimates are highly correlated. The yk1
measure suggests that the economy has been operating at above potential since
1993. Also note that yk2 is similar to the trend through peaks estimates in that
the estimated output gap is by construction always negative. Both series suggest
that the degree of spare capacity has declined sharply over the last two years.
The production function approach
The previous two approaches related potential output to either some measure of
labour input or some measure of capital input. By contrast, the production
function approach relates potential output to both labour and capital inputs, and
by so doing should yield better estimates of potential output.
Only one potential output series was estimated using this technique. The
functional form chosen for the estimated production function was the constant
elasticity of substitution (CES) function. The estimated function was of the
following form:
⎡
LF E H
Q= PWA• ⎛ ⎝ ⎜ ⎞
⎟ • ⎛ PWA⎠
⎝ ⎜ ⎞
⎟ • ⎛ −ρ
⎛
LF⎠
⎝ ⎜ ⎞⎞
⎢α⎜
⎟⎟ + − •
⎝
E ⎠⎠
⎣⎢
( 1 α)( QCU K)
1
ρ
−ρ
⎤
⎥
⎦⎥
13
This rate was chosen based on previous work at the Reserve Bank (See Brooks and
Gibbs, 1991).