remarks by lawrence schembri deputy governor of the bank of canada ottawa economics association and cfa society ottawa ottawa, ontario may 16, 2018 the ( mostly ) long and short of potential output introduction thank you for inviting me here today. an important, if sometimes underappreciated, purpose of central bank speeches is to help the public understand what we are trying to achieve, and why. a greater understanding of our monetary policy actions helps make them more effective. and as a public institution, we have an obligation to highlight and demystify the concepts that guide our thinking in a way that all interested citizens, not just the experts in this room, can grasp. few in the public likely give much thought to potential output, for example. yet this somewhat abstract notion is vital to how most central banks evaluate inflationary pressures and conduct monetary policy. at the bank of canada, being able to estimate and project potential output has contributed notably to our strong track record of meeting our inflation objectives. at the same time, the dynamics of potential output are primarily shaped by slow - moving forces that can take time to have a material impact, such as demographic shifts, capital accumulation and technological change. equally important, many of these same forces influence a country ’ s standard of living. a significant development in recent decades is that growth in potential output has been on a generally downward trend in most major advanced economies, including canada, largely owing to the aging of our populations. this trend has important implications for our macroeconomic policy frameworks and for our economic prospects. i would like to thank dany brouillette for his help preparing this speech. not for publication before may 16, 2018 12 : 15 p. m. eastern time my remarks today are organized around four separate but closely related questions : 1. what is potential output? 2. how do we measure it? 3. why is it important for policy? 4. what policies have supported potential output growth in the past and could again in the future? the answers to these questions should help you better understand not only our policy in the near term, but also our thinking about policy - making over a longer horizon. what is potential output? turning to the first question, we usually refer to “ potential ” in the context of individual achievement, as in “ realizing one ’ s potential. ” when i was much younger, for example, my aspirations for my own potential included growing as tall as my favourite player on the dallas cowboys, becoming a pitcher for the toronto blue

the spectrum that are part of the bank ’ s staff tool box. vii chart 5 : estimates of potential output growth from four different models year - over - year percentage change % integrated framework extended multivariate filter multivariate state - space framework basic multivariate filter source : bank of canada estimates last observation : 2018q1 models that incorporate an economic structure are especially useful for projecting tlp growth, since tlp is based on variables and relationships that are difficult to measure and predict. tli growth is comparatively easier to forecast because it is based on accurately observed labour market outcomes : the employment rate, the working - age population and average hours worked. in contrast, tlp growth depends on two variables that are less concrete and therefore more challenging to observe precisely. the first of these, capital deepening, is a measure of growth in the ratio of capital per hour worked. viii the second is a more elusive concept called trend total factor productivity, or tfp. while we have some observable measures of investment and capital stock growth, we do not have the same for trend tfp — which essentially includes everything affecting firms ’ productivity that isn ’ t captured by capital stock growth. these “ residual ” factors include, for example, technological improvements and the impact of education and training. ix another way that the bank manages the uncertainty around potential output growth is by conducting an in - depth review of our projections on an annual basis. first, economic data are regularly revised, so for that reason alone an annual review makes sense. also, our empirical techniques are “ living ” in a sense — we are continually improving them as we learn from experience and ongoing research. x plus, in the annual reassessment, we further account for uncertainty by publishing ranges around our estimates and projections that expand with time. we also list the factors that could lead potential growth to be lower or higher within those ranges. xi i would like to stress that the bank recognizes the difficulties associated with measuring potential and the related uncertainty, and so takes a deliberate and rigorous approach to managing this uncertainty. we work hard to ensure that our models evolve in line with prevailing best practices. and on top of using multiple techniques, we corroborate the models ’ results against other measures of capacity and inflation, and then apply wellinformed judgment. finally, the uncertainty around these estimates is taken into account in the formulation of monetary policy. this helps us ensure that our estimates and our policy decisions are consistent with our broader economic outlook