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Prepared by Manmohan S. Kumar.
The non-accelerating inflation rate of unemployment (NAIRU) is the most widely-used measure of the natural rate of unemployment; an alternative measure, the non-accelerating wage rate of unemployment (NAWRU), a measure more explicitly linked to the labor market, is the focus of Section E.
This technique has been used extensively by the OECD. (See, for instance, Giorno and others, 1995) The UK Treasury uses a variant of this technique whereby trend output is calculated by linear interpolation between successive on-trend points at like stages of the cycle.
This method was used by Artus (1977) for estimating potential output in the manufacturing sector for 8 industrial countries for the period 1955–1975. Adams, Fenton, and Larsen (1987) broadened the coverage for the manufacturing sector to the economy as a whole.
In the empirical estimation, the weights on capital and labor were first obtained endogenously—that is, by estimating an unconstrained augmented production function.
The Treasury panel also makes a distinction between short-term and long-term output gaps with the former measuring the difference between actual and trend output when the capital stock is held fixed and the latter measuring that difference when the capital stock is allowed to vary.
The London Business School, using a framework similar to that adopted by the National Institute, also suggests that the potential growth rate over the next decade is likely to average between 2.4 and 2.9 percent per annum (see Sentance, 1995).
Earlier estimates, based on a variety of techniques, suggested trend output growth to be around 2¼ percent (see Giorno and others, 1985).
For the HP filter and the production function estimates, this entailed setting the value of λ to 1600. In the Blanchard-Quah estimates, the same parameter value was used for detrending the unemployment rate; the split time-trend does not require any smoothing.
Estimates for the first quarter of 1996 should be regarded as preliminary.
While full employment of all resources places a barrier on noninflationary increments to employment, it does not necessarily fix the rate of growth (see, for example, Mundell (1996)). Given full employment, potential output can be increased by raising the saving rate or productivity growth.