Policy implications of standard consensus models are typically derived from simulations that rely on specific assumptions with regard to the equilibrium level of production. Thereby, the evolution of equilibrium output rests on an asymmetric separation of supply-side and demand-side adjustment to macroeconomic shocks. In particular, this consensus perspective does not account for demand-side stimulus on an economy’s productive capacity.
The record of the Phillips-curve extensively documents the fact that output gap dynamics have constituted the explanation of the evolution of inflation for the most part and, therefore, have been used as a central building block within models designed for monetary policy research. Against the background of such popularity of output gaps for stabilization purposes, one can easily identify equilibrium output as a central concept within the framework of stabilization analysis.
Macroeconomic literature has introduced several terms and concepts of the equilibrium level of production (see McCallum, 2001, 261). The most common and intuitive understanding of potential output in the context of macroeconomic stabilization research has been connected to the contribution of Okun (1962). Okun (1970, 132-133) defines the equilibrium level of output as ”the maximum production without inflationary pressure, [ ...] or more precisely [...] the point of balance between more output and greater stability.” The concept matches the maximum amount of production from a technical point of view with the degree of factor-utilization that may provide a stable development of goods prices (e.g., Macroeconomic Policy Institute, 2007, 30 and Kuttner, 1994, 361).
According to this, rather than solely on the technical dimension, stabilization policy primarily focuses on the level of production that may be in line with a stable development of goods and factor prices (see European Central Bank, 2000, 37-38 and European Central Bank, 2005, 46). This perspective is also highlighted by Hall and Taylor (1991, 16) as they define the concept of equilibrium production as ”the amount of output that would have been produced had the economy been in neither boom nor recession [...] from the existing capital stock and labor force.”
Download
Interest Rate Policy and Supply-side Adjustment Dynamics
