Potential output is an important concept in economics. Policymakers often use a one-sector neoclassical model to think about long-run growth, and often assume that potential output is a smooth series in the short run–approximated by a medium- or long-run estimate. But in both the short and long run, the one-sector model falls short empirically, reflecting the importance of rapid technical change in producing investment goods; and few, if any, modern macroeconomic models would imply that, at business cycle frequencies, potential output is a smooth series. Discussing these points allows us to discuss a range of other issues that are less well understood, and where further research could be valuable.
Fernald, John G., and Susanto Basu. 2009. “What Do We Know and Not Know about Potential Output?,” Federal Reserve Bank of San Francisco Working Paper 2009-05. Available at https://doi.org/10.24148/wp2009-05