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Minding the Output Gap: What Is Potential GDP and Why Does It Matter?
Potential output is an estimate of what the economy could produce. Actual output is what the economy does produce. If actual is below potential -- a negative output gap -- there is "slack" in the economy. If actual is above potential -- a positive output gap -- resources are fully employed, or perhaps overutilized. This issue of Page One Economics explains how the output gap is useful for checking the health of the economy. It also points out how errors in the estimation of potential real GDP can reduce the effectiveness of policy.
Working Paper
Supply-Side Effects of Pandemic Mortality: Insights from an Overlapping-Generations Model
We use an overlapping generation model to explore the implications of mortality during pandemics for the economy's productive capacity. Under current epidemiological projections for the progression of COVID-19, our model suggests that mortality will have, in itself, at most small effects on output and factor prices. The reason is that projected mortality is small in proportion to the population and skewed toward individuals who are retired from the labor force. That said, we show that if the spread of COVID-19 is not contained, or if the ongoing pandemic were to follow a mortality pattern ...
Working Paper
The Impact of COVID on Productivity and Potential Output
The U.S. economy came into the pandemic, and looks likely to leave it, on a slow-growth path. The near- term level of potential output has fallen because of shortfalls in labor that should reverse over time. Labor productivity, to a surprising degree, has followed an accelerated version of its Great Recession path with initially strong growth followed by weak growth. But, as of mid-2022, it appears that the overall level of labor and total factor productivity are only modestly affected. The sign of the effect depends on whether we use the strong income-side measures of pandemic output growth ...
Working Paper
A State-Level Analysis of Okun’s Law
Okun?s law is an empirical relationship that measures the correlation between the deviation of the unemployment rate from its natural rate and the deviation of output growth from its potential. In this paper, we estimate Okun?s coefficients for each U.S. state and examine the potential factors that explain the heterogeneity of the estimated Okun relationships. We find that indicators of more flexible labor markets (higher levels of education achievement in the population, lower rate of unionization, and a higher share of nonmanufacturing employment) are important determinants of the ...
Working Paper
The Impact of COVID on Potential Output
The level of potential output is likely to be subdued post-COVID relative to its previous estimates. Most clearly, capital input and full-employment labor will both be lower than they previously were. Quantitatively, however, these effects appear relatively modest. In the long run, labor scarring could lead to lower levels of employment, but the slow pre-recession pace of GDP growth is unlikely to be substantially affected.
Working Paper
What Can the Data Tell Us About the Equilibrium Real Interest Rate?
The equilibrium real interest rate (r*) is the short-term real interest rate that, in the long run, is consistent with aggregate production at potential and stable inflation. Estimation of r* faces considerable econometric and empirical challenges. On the econometric front, classical inference confronts the "pile-up" problem. Empirically, the co-movement of output, inflation, unemployment, and real interest rates is too weak to yield precise estimates of r*. These challenges are addressed by applying Bayesian methods and examining the role of several "demand shifters", including asset ...
Working Paper
A State-Level Analysis of Okun's Law
Okun's law is an empirical relationship that measures the correlation between the deviation of the unemployment rate from its natural rate and the deviation of output growth from its potential. This relationship is often referred to by policy makers and used by forecasters. In this paper, we estimate Okun's coefficients separately for each U.S. state using an unobserved components framework and find variation of the coefficients across states. We exploit this heterogeneity of Okun's coefficients to directly examine the potential factors that shape Okun's law, and find that indicators of more ...
Working Paper
Productivity and Potential Output Before, During, and After the Great Recession
U.S. labor and total-factor productivity growth slowed prior to the Great Recession. The timing rules explanations that focus on disruptions during or since the recession, and industry and state data rule out ?bubble economy? stories related to housing or finance. The slowdown is located in industries that produce information technology (IT) or that use IT intensively, consistent with a return to normal productivity growth after nearly a decade of exceptional IT-fueled gains. A calibrated growth model suggests trend productivity growth has returned close to its 1973-1995 pace. Slower ...