Estimating Potential Output for Pakistan: A Production Function Approach

Abstract

Measures of potential output and the output gap are useful to help identify the scope for sustainable non-inflationary growth and to allow for an assessment of the stance of macroeconomic policies. In this paper, we apply the aggregate production function to estimate the path of potential output over the sample period 1973-74 to 2007-08. Time-varying Non- Accelerating Inflation Rate of Unemployment (NAIRU) is used to derive the amount of potential labour and perpetual inventory method to measure capital stock to account for the productive impact of capital. In addition, trend total factor productivity is estimated. The results show that Pakistan was growing above its potential output from 2003-04 to 2006-07 and in 2007-08 potential output was above actual output. This observation is also consistent with the behavior of NAIRU in which NAIRU declined from 2004-05 to 2007-08 from 8.12 percent to 6.17 percent. Actual employment was above potential employment from 2002-03 to 2007-08. These results provide some evidence that Pakistan’s economy was facing excess demand from 2003-04 to 2006-07 and in 2007-08 the situation is opposite and in a labor-surplus economy there is need for more labor-intensive techniques of production to avoid the possibility of jobless growth.