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PBO’s Approach to Measuring Potential GDP
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Potential GDP is a measure of the sustainable productive capacity of an economy. It is typically defined as the level of output that can be achieved with available resources (e.g., labour, capital and technology) without creating inflationary pressures. As such, potential GDP provides a natural benchmark for assessing economic performance at a macro level.
Both the level and growth rate of potential GDP can be influenced by actual economic conditions as well as government policies. Ultimately, an economy’s capacity to generate increases in living standards and to support government programs is tied to potential GDP.
Potential GDP is not directly observable and therefore must be estimated. PBO uses a standard “production-function” approach to construct estimates of potential GDP over history and projection horizons. This approach measures the amount of output an economy can produce when labour, capital and technology are at their respective trends.
To calculate potential GDP, we incorporate our estimates of trend labour, capital and trend total factor productivity—a measure of technological progress—into a conventional production function.
Based on our April 2018 Economic and Fiscal Outlook, we estimate that real GDP rose above potential GDP in the second quarter of 2017 and stood at 0.7 per cent above potential at the end of 2017.
Looking ahead, we project growth in potential GDP to rebound from 1.2 per cent in 2017 to reach 1.8 per cent in 2020 and 2021. This projected rebound is due to an acceleration in capital accumulation and faster growth in trend total factor productivity.
Compared to other institutions that produce estimates of potential GDP, PBO’s estimate of potential growth in 2017 is at the lower end, likely reflecting both weaker growth in trend labour productivity and trend labour input. However, over the medium term, our projected growth in potential GDP is in line with the Bank of Canada’s projection.