Potential GDP

Brad DeLong uses an old analytical tool, called Okun's Law, to argue that potential GDP is growing at a 3.5 percent rate.

Over the 1960-2001 period, real GDP grew at an average rate of 3.4% per year. When unemployment fell, GDP grew by more--a 1%-point fall in the unemployment rate being enough to push the annual rate of GDP growth up by 2%-points; a 1%-point rise in the unemployment rate being enough to push the annual rate of GDP growth down by 2%-points.

By taking out the 2-for-1 relationship between GDP and unemployment (Okun's Law) and doing some smoothing, you can arrive at an estimate for growth in potential GDP. This is an entirely empirical estimate, with no analysis of the underlying causes of growth in potential GDP. It tells a convincing story of the past, but not the future. If you are going to forecast growth in potential GDP, then it seems to me that you have to forecast its components, which are labor force growth, growth in the capital-labor ratio, and growth in what used to be called "the residual" (driven by technological change, education, and so forth).

Discussion Question. Because of high rates of immigration in the 1990's, the labor force grew more rapidly in the United States than in other developed countries. Is this likely to continue?