Potential Output in Theory and Practice: A Revision and Update of Okun`s Original Method

Claudia Fontanari (), Antonella Palumbo and Chiara Salvatori ()
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Claudia Fontanari: Roma Tre University.
Chiara Salvatori: Roma Tre University.

No 93, Working Papers Series from Institute for New Economic Thinking

Abstract: This paper challenges the mainstream view of potential output, and enquires into the supposed effects of Great Recession on potential growth. We identify in the demand-led growth perspective a more promising theoretical framework both to define the notion and to gauge the long-term effects of a demand slow down. Based on the poor reliability of standard estimates of potential output, we also propose an alternative calculation. This is based on an update of Arthur M. Okun`s original method for estimating potential output, which, differently from the estimation methods currently in use, does not rely on the notion of NAIRU, thus being immune to its theoretical and empirical shortcomings. Our calculation, based on a re-estimation of Okun`s Law on US quarterly data, shows both how far an economy generally operates from its production possibilities, and how much potential growth is affected by the actual growth of demand over time. These wide margins for expansion of actual and potential output growth imply that a determined policy of demand expansion would create, given time, the very capacity that justifies it.

Keywords: potential output; Okun`s law; unemployment; demand-led growth (search for similar items in EconPapers)
JEL-codes: C22 E11 E12 E23 E24 E60 O40 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2019-03
New Economics Papers: this item is included in nep-hme and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Related works:
Journal Article: Potential Output in Theory and Practice: A Revision and Update of Okun's Original Method (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:93

DOI: 10.2139/ssrn.3419280

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