Potential output is an important concept in economics. Policymakers often use a one-sector neoclassical model to think about long-run growth, and 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 long run, the one-sector model falls short empirically, reflecting the importance of rapid technical 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 us to discuss a range of other issues that are less well understood, and where further research could be valuable.
About the Authors
John G. Fernald is an Economist Emeritus and former senior policy advisor in the Economic Research Department of the Federal Reserve Bank of San Francisco, and a professor of economics at INSEAD. Learn more about John G. Fernald