What do we know (and not know) about potential output?

Abstract

Potential output is an important concept in economics. Policymakers often use a one-sector neoclassical model to think about long-run growth, and they often assume that potential output is a smooth series in the short run-approximated by a medium- or long-run estimate. But in both the short and the long run, the one-sector model falls short empirically, reflecting the importance of rapid technological change in producing investment goods; and few, if any, modern macroeconomic models would imply that, at business cycle frequencies, potential output is a smooth series. Discussing these points allows the authors to discuss a range of other issues that are less well understood and where further research could be valuable. © 2009, The Federal Reserve Bank of St. Louis.