The Concept of Potential Output: A History of Origins

This chapter outlines the economic conditions and theoretical ideas prevailing at the times of origin of the concept of potential output. In general, Okun (1962) is considered as the starting point for the development of methods for calculating potential output and output gaps (Section 2.2). However, the standard methods have been heavily criticised by proponents of the New Neoclassical Synthesis who in turn refer to Wicksell’s theory of interest rate gaps, which dates back as early as 1898 (Section 2.3). Accordingly, this chapter outlines the extensive history of potential output concepts before Okun (1962), especially with respect to the development of Wicksellian and Keynesian “gap theories” since the late 1920s (Section 2.4). Since controversies about the existence of a trade-off between full employment and price-level stability are of central importance for the discussion of potential output, the different stages of the Phillips curve debates are described in Section 2.5. The development of systems of national accounting, which began in the 1930s and culminated after World War II, did also play an important role. Based on national accounting, numerous methods of calculation have been developed since the 1960s for purposes of political advisory. At the end of this chapter, it is discussed to what extent connections can be made between concepts of potential outputs and the macroeconomic framework conditions prevailing at their respective times of origin (Section 2.6). When gap theories were developed around 1930, circumstances were, after all, very different compared to the heyday of potential output concepts in the 1960s and 1970s. The corresponding macroeconomic framework conditions are captured in terms of growth regimes that give priority to the relationship between real growth rates and real interest rates – two key determinants of investment.