The natural rate of output, supply side potential and the long term sustainable growth band for Malaysia

Abstract

To achieve a developed country status, Vision 2020 targets to maintain Malaysia's real GDP growth at an annual rate of 8% from 1990 to 2020. The estimation of this long term sustainable growth is crucial for the formulation of macroeconomic policies to prevent either overheating or not optimising the economy. Hence, this paper attempts to estimate the natural rate of unemployment and sustainable growth of Malaysia by employing the Lucas-Sargent aggregate supply function, which is although equivalent to the Price Expectations Augmented Phillips curve (PEP). A structural approach that integrates the goods, labour and money market and the external trade sector specific to the Malaysian economy, with the incorporation of rational expectations into the economy will be used. We aim to establish the initial stage of uncovering this potential growth so that policy makers could tailor the economy along this rate with minimal fluctuations, uncertainty and resource misallocation.