output gap

Think of an economy as a car with a comfortable cruising speed — the pace it can keep up indefinitely without straining the engine. Sometimes it putters along below that speed, with empty seats of unused capacity; sometimes it floors the accelerator and runs hotter than it can sustain. The output gap measures exactly how far the economy is running above or below its comfortable cruising speed at any moment.

Precisely, the output gap is the difference between actual output (real GDP right now) and potential output (what the economy could produce with its resources fully and sustainably employed), usually written as a percentage of potential. When actual output is below potential, the gap is negative — a recessionary gap, with idle factories and people who want work but can't find it. When actual output is above potential, the gap is positive — an inflationary gap, where the economy is overheating, labour and materials are scarce, and prices tend to rise. For example, if potential GDP is 100 and actual GDP is 96, the output gap is −4 percent: the economy is producing 4 percent less than it sustainably could.

The output gap is one of the most-watched numbers in macroeconomics because it points policy in a direction: a big negative gap signals room to stimulate without much inflation, while a positive gap warns of overheating. But it comes with a heavy caveat — potential output cannot be observed directly; it has to be estimated, and those estimates are uncertain and often revised. So the output gap is a useful compass, not a precise gauge, and reasonable economists can disagree about whether an economy is above or below potential at any given time.