Potential Output: Concepts and Measurement - Department of Labour

Darren Gibbs 105
TABLE 1: Estimated potential growth rates and magnitude of output gap
Method used Growth rate Output gap
tp1 2.21
tp2 1.06
yl1 4.05 -1.52
yl2 3.54
yk1 3.16 3.43
yk2 1.52
pf1 1.39 1.34
hp1600 1.73 3.41
hp200 3.55 1.52
hp100,000 1.10 3.53
bf1600 3.55 -0.25
bf200 5.42 -1.10
bf100,000 1.50 -0.20
mfa1600 2.79 -0.90
mfa200 4.19 -1.95
mfa100,000 1.62 -1.83
mfb1600 3.76 -0.76
mfb200 4.94 -1.75
mfb100,000 1.66 -0.35
As Table 1 illustrates the various measures produce vastly different
conclusions regarding the potential growth rate over the year to March 1994, and
the size and sign of the output gap. If, for example, mfa200 is the correct estimate
of potential output then, assuming the potential growth rate over the year to
March 1995 is the same as in 1994, this would imply that the economy could
sustain a further 6.1 percent before the output gap termed positive and pressures
on inflation developed. 16 On the other hand, if pf1 is the correct estimate of
potential output, then the estimates suggest that inflationary pressures are likely
to have been developing since the beginning of last year. The question is, how
does one select which (if any) is the best estimate?
5 Econometric properties of estimated output gaps
In section 4 we estimated 19 different output gaps. Given that the different
estimates led to different conclusions, the usefulness of these measures will be
limited; unless one estimate can be isolated as being superior to the rest, or the
range of valid alternatives can at least be narrowed down. In this section we
make use of both correlation and regression analysis in an attempt to do
just that.
16
The estimate of 6.1 percent is calculated by summing last period’s output gap and the
negative of the estimated potential growth rate.