A Non-Inflationary Potential Output in Question

Abstract

The output gap measurement helps assess a country’s growth performance, fiscal space and to forecast inflationary pressures. It is measured based on the ‘potential output’. The latter captures the notion that there is an equilibrium level of production and policymakers try to reach an economic environment consistent with the operation of the economy at this equilibrium. This article put the non-inflationary potential output approach in question. This is because, a non-inflationary long term equilibrium would require in the short run a non-inflationary economic environment which entails, according to Phillips curve, a stable unemployment rate implying then that some people who can and are willing to work will not find jobs. The alternative methodology we proposed, to measure the potential output, and therefore the output gap, relied on the hypothesis that labor is the production factor that produces and uses capital as well as develops technology. Thus, the economy will reach its potential output when the unemployment rate is zero. This methodology enables to align macroeconomic policies objectives in order to support employment. The unemployed willingness to work won’t be offended by macroeconomic policies that put a non-inflationary equilibrium as an ultimate objective. Besides, this methodology suggests that; policies aiming to increase the labor force as well as policies aiming to increase the real productivity by worker can expand the production capacity of the economy i.e., its potential output. It also suggests that; policies aiming to reduce the unemployment rate can help the economy reach full employment i.e., its full capacity.