The concept of potential output plays an important part in economic policy. It is applied in Taylor rules for monetary policy as well as in the calculation of structural budget deficits. However, as an unobservable variable potential output is subject to significant uncertainty.
Two parallel projects on "Methodological Issues of Medium-Term Macroeconomic Projections - The Case of Potential Output" (Methodologische Fragen mittelfristiger gesamtwirtschaftlicher Projektionen am Beispiel des Produktionspotenzials) funded by the German Ministry of Economics and Technology have analysed and assessed existing methods of potential output estimation. The researchers from the Macroeconomic Policy Institute (IMK, Düsseldorf) and from the Centre for European Economic Research (ZEW, Mannheim) presented their results at the workshop.
More than 70 experts from international organisations -such as the OECD, the European Commission and the ECB - as well as from research institutes, universities and ministries contributed to the lively debate. Most participants agreed that the uncertainty of potential output estimates and their frequent and substantial revisions are highly problematic. There was more controversy about the conclusions to be drawn. Whereas the IMK advised central banks to look at unit labour cost rather than the uncertain output gap, most experts still adhere to an econometrically estimated output gap as a useful guideline for economic policy makers.
Draft summaries of the two institutes' studies can be downloaded from this site. The full studies will become available on this site in German and English soon.