Productivity and the Output Gap: A Frontier Perspective
Kevin J. FoxABSTRACT
Research Question/Issue
The output gap guiding monetary policy measures actual output against potential output defined by stable inflation and full employment. This paper proposes a different benchmark: a production frontier, the output attainable from the inputs actually employed using best practice already demonstrated.
Research Findings/Insights
For the Australian market sector there was essentially no gap in 2003‐04. It has since widened to 15 per cent of frontier output, around $260 billion of forgone value added in 2024‐25, with Mining, Utilities and Construction accounting for 80 percent of the shortfall. Unlike the conventional output gap it is one‐sided and persistent.
Practitioner/Policy Implications
Trend productivity absorbs this inefficiency, so conventional potential output estimates understate the output technologically attainable from existing inputs. A recovery in efficiency would raise output while easing rather than adding to inflationary pressure.
Methods Used
The Diewert and Fox (2018) nonparametric value added decomposition, applied to ABS industry and state multifactor productivity data for 1989‐90 to 2024‐25. The analysis is descriptive, requiring no filter, unobserved‐components model or NAIRU assumption.