ECONOMIC

The statistical methods used to adjust for cyclical variations in productivityare necessarily based on the presumption that the variations in productivityover the business cycle are related in a stable way to measures ofthe cycle, such as the unemployment rate and capital utilization rates.Since the data indicate that the current slowdown may have produced anatypical reaction in productivity, it is possible that productivity will continueto increase and reach its former trend in the next 2 years. This possibilitywould imply private productivity growth rates for 1977 and 1978 wellin excess of the 2 percent trend.On the other hand, it has been nearly 2 years since the recession reachedits trough, and there has been little evidence of cyclical productivity gainsthis late in previous recoveries. Because of this uncertainty regarding thepermanence of the recent decline in productivity, estimates of potentialoutput will be similarly uncertain. The estimates of potential GNP presentedin Table 6 and Chart 4 do not include a shift in the level of productivityin 1973-74, but instead assume that the downward movement willbe offset by an equivalent upward movement as recovery continues. Theperformance of the economy over the next 2 years will indicate whetheror not a further revision in the estimates of potential GNP is necessary.POLICY IMPLICATIONSNeither potential GNP nor the full-employment unemployment ratewill be reached in 1977. However, both may set limits to growth in comingyears which cannot be exceeded without risking accelerating inflationand renewed instability. For example, the uncertainty that surrounds theestimates of potential output implies that caution must be observed aspotential GNP is approached. If the 1974-75 reduction in the level ofproductivity proves to be permanent, physical capacity constraints similarto those encountered in 1973 may appear well before an unemploymentrate of 4.9 percent is reached. If so, they will seriously interfere with ourfull-employment goals.As discussed previously, there are reasons to believe that the fullemploymentrate may be above the 4.9 percent benchmark we haveused to estimate potential output. In any case, policy makers should realizethat a 4 percent goal is not likely to be sustainable in the current economicenvironment; and because of the tentative nature of the full-employmentrate estimates they should watch closely for signs of accelerating wage inflationwhen the overall rate of unemployment falls to about 5J4 percent.The analysis suggests, for example, that the 4.9 percent unemployment ratein 1973 may have been partly responsible for the accelerating inflation in1973-74, although this interpretation is clouded by other events such as thewage and price controls and the extraordinary increases in the prices of foodand fuel. It also suggests that economic programs which aim to reduceunemployment in particularly depressed areas or among disadvantaged56