Unnecessary Instability

PARIS – In normal life, technicalities are better left to technicians. A car owner does not need – or usually want – to bother to find out what exactly goes on under the hood. But when the car breaks down, he or she often has no choice.

What is true of cars applies to the economy: arcane issues are for specialists. Yet in recent years, topics about which most people had never heard or cared – for example, securitization, credit default swaps, and the European payment system known as Target 2 – have imposed themselves on public debate, forcing ordinary people to grapple with their intricacies.

The same has started to happen with the notion of “potential output growth.” Originally a concept created by economists for economists, its use for determining when, and by how much, a public deficit must be corrected is becoming a matter for wider discussion. Indeed, its unreliability is seriously weakening the EU’s fiscal pact – which makes it necessary to open the hood and look inside.

The aim of the concept of potential – as opposed to actual – GDP is to take into account that, like an engine, an economy often operates below or above potential. In a demand-driven recession, actual output falls below potential, which results in a rise in unemployment. Similarly, a credit-fueled construction boom drives output above potential, resulting in inflation.