2.5.2 Output gaps

Actual growth

the percentage increase in a country’s real GDP and it is usually measured annually. It is caused by increases in AD

Potential trend of GDP

the long run expansion of the productive potential of an economy

Positive and negative output graph

Positive output gap

the economy is performing over its potential overusing its resources

Negative output gap

the economy is not using its resources effectively enough

Output gap

difference between actual GDP and potential GDP, measured as a percentage of national output

When does negative output gap occur?

when the actual level of output is less than the potential output. Downward pressure on inflation means the unemployment of resources in an economy, so labour and capital are not used to their full productive potential. This means there is a lot of spare capacity in the economy

When does positive output gap occur?

gap occurs when the actual level of output is greater than the potential level of output. It could be due to resources being used beyond normal capacity. If productivity is growing, the output gap becomes positive.

Potential trend GDP graph

Actual GDP graph

Difficulties of measuring the output gap

* It is difficult to estimate the trend in a series of data.
* The structure of the economy often changes which means estimates may not always be accurate.
* Changes in the exchange rate might offset some inflationary effects of a positive output gap.
* Data is not always reliable, and extrapolating data from past trends might lead to uncertainties.

Negative output gap in long run graph

Positive output gap in short run

Negative output gap in the SR