The Empirical Relationship Between Real Output, Potential Output, and Policy Variables

Abstract

Economists working at the Federal Reserve Banlc of St. Louis have crested an approximation of potential output. This paper studies the relationship between this proxy for potential output and the value of real output as well as whether policy variables influence the path of real output. Modern theoretical models suggest that there is a direct relationship between the level of potential output and the level of real production therefore, recent innovations in time-series methods will be used to study the relationship between this proxy of potential output and the level of real output. The results of these tests indicate there is a long-run relationship between this proxy for potential output and real output, but that no relationship exists between the value of the policy variables and the value of real output. These results support the real business cycle theory. (El, E32)