By Robert Shackleton (CBO)
As part of its responsibility for producing baseline projections of the economy and the federal budget, CBO regularly produces estimates and projections of potential output, a measure of the economy’s fundamental ability to supply goods and services. The projection of potential output serves as a key input to CBO’s macroeconomic forecasts and budget projections, helping the agency maintain consistency between its projections of labor supply and capital accumulation and its projections of taxes on income from labor and capital, of federal expenditures, and of the accumulation of public debt. This paper updates the agency’s description of the data sources, analytic methods, and modeling framework that it uses both to estimate historical values of the components of potential output and to project those values into the future. It describes the major changes that CBO has introduced in its approach since it last published a methodological description in 2001, outlines the linkages between its analysis of potential output and other elements of its economic and policy analysis, and discusses some of the major challenges associated with understanding and projecting recent trends in fundamental components of the economy.