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New estimates of the U.S. economy's potential growth rate

  • George A. Kahn

Using an Okun's law framework, this paper estimates potential growth for the 1990s as measured by both fixed-and chain-weighted indexes of GDP. Estimated potential growth rates are then decomposed into growth in labor productivity and growth in labor input using a regression analysis to separate secular from cyclical changes. Estimates of potential output and trend productivity growth for the 1990s are compared with estimates from earlier periods using both fixed and chain weights. ; The first section of the paper compares the behavior of output, productivity, and employment during the current recovery with past recoveries noting the unusually large contribution of productivity growth to output growth early in the current recovery. The second section uses a version of Okun's law to estimate the economy's potential growth rate. The third section uses an output identity to determine the relative contribution of productivity and employment growth to potential output growth. ; The paper concludes that eliminating the substitution bias associated with fixed-weight measures of real GDP raises estimated potential GDP growth in the 1980s but lowers estimated potential GDP growth in the 1990s. As a result, potential growth is estimated to have slipped from roughly 2.5 percent per year in the 1980s to roughly 2.0 percent in the 1990s. Decomposing potential growth into productivity growth and growth in labor input shows that this slowdown has occurred despite a modest increase in estimated trend productivity growth. Based on chain-weighted data, trend productivity growth is shown to have increased from 0.9 percent per year in the 1980s to 1.2 percent in the 1990s--perhaps boosted modestly (but statistically insignificantly) by business downsizing and investment in new plant and equipment. Finally, the increase in productivity growth has not translated into an increase in potential output growth because of a secular decline in the growth rate of aggregate hours worked.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number 95-08.

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Date of creation: 1995
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Handle: RePEc:fip:fedkrw:95-08
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