Analysis and Criticism of Conventional Methods of Estimation

The history of the idea of potential output (chapters 2 and 3) shows how difficult it is to pin down this concept even from a purely theoretical perspective. How much more difficult must it, therefore, be to come up with an empirical definition of potential growth? A series of standard procedures for determining potential output have, nonetheless, been established in recent decades and are considered in the following. While theoretical criticism of these concepts and doubts about a strict dichotomy between growth and the business cycle have been discussed in detail in chapter 2, this chapter spotlights the empirical features and data requirements of these methods. Section 5.2 begins by reviewing the literature and the findings of a project performed by the ZEW in 2005 on behalf of the German Federal Ministry of Economics and Technology and briefly sketches the most important procedures for estimating potential output and potential growth. The ZEW project dating from 2005 examined medium-term macroeconomic projection methods used by government agencies in major industrialised countries and international institutions. As shown by both a questionnaire survey conducted by the ZEW and an appraisal of the relevant literature, official institutions use a vast array of different methods and models for the purpose of constructing medium-term projections. In each case, however, key importance is attached to the concept and empirical implementation of potential output.