Output Gap
The output gap is the difference between what an economy actually produces and an estimate of what it could produce at full, sustainable capacity. A positive gap points to inflation pressure; a negative one to slack. It cannot be measured directly, so estimates differ.
The output gap compares what an economy actually produces with an estimate of what it could produce at full, sustainable capacity. A positive gap points to inflation pressure; a negative one to spare capacity. Because potential output cannot be seen, every estimate is a model.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- GDP gap, Potential output gap
- Updated
The output gap in plain words
The output gap is the difference between what an economy actually produces and what it could produce at its potential.1
A positive gap means the economy is running above its full capacity.1 A negative gap means it is producing less than it could.1
In the US, a common benchmark is the CBO's estimate of potential GDP — the output the economy could produce while making high use of its workers and capital.2
How an output gap is estimated
Measure actual output
Use real Gross Domestic Product.
Estimate potential output
Pick an estimate of potential output, such as the CBO's potential GDP.2
Compute the gap
Gap % = (actual − potential) ÷ potential × 100.1
Read the sign
A positive reading means output is above capacity.1
Link to inflation
Use it as a gauge of future inflation pressure.1
Allow for error
The output gap cannot be observed directly, so compare several estimates.1
Worked examples
Example 1 — Overheating
Inflation riskHypothetical actual GDP is 1,030 and potential is 1,000.
| Gap | +3% |
Output is running above capacity, so prices are likely to face upward pressure.1
Example 2 — Slack
Spare capacityHypothetical actual GDP is 960 and potential is 1,000.
| Gap | −4% |
Output is below capacity, leaving workers and machines idle.1
Example 3 — Revised estimate
Estimates shiftA hypothetical gap first estimated at −2% is later revised to 0% after potential is re-estimated.
| First estimate | −2% |
| Revised | 0% |
Revisions happen because the output gap cannot be observed directly.1
Positive vs negative output gap
| Aspect | Positive gap | Negative gap |
|---|---|---|
| Output vs potential | Above | Below |
| Inflation pressure | Upward | Downward |
| Labour market | Tight | Slack |
| Typical policy response | Tighter policy | Looser policy |
Where the output gap is used
Monetary policy
Central Bank staff weigh it when setting the Interest Rate.
Inflation forecasting
A positive gap points to higher Inflation.
Recession analysis
Gaps turn negative in a Recession.
Bond markets
Gap estimates shape expectations for Treasury Bills, Notes and Bonds yields.
Advantages and disadvantages
Advantages
- Summarises the cycle in one number.
- Links activity to inflation.
- Used widely by policymakers.
Disadvantages
- Potential output is unobservable.
- Estimates are revised heavily.
- Different methods give different answers.
- Hard to use in real time.
Going deeper
Read as far as you need. Each level builds on the one before it.
Actual vs possible
Beginner
It compares actual output with potential output.1
Why central banks care
Intermediate
Central banks watch it closely because it is a major driver of inflation.1
Measurement problems
Advanced
Potential output can't be observed directly, so the gap is always an estimate.1 Filters, production functions and surveys all disagree, and official estimates differ by country.
Common mistakes
Treating estimates as facts
They are model outputs.
Ignoring revisions
Real-time gaps often change later.
Assuming one gap fits all
Each country's potential differs.
Reading a zero gap as no risk
Supply shocks can still lift inflation.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- The gap is actual minus potential output.
- Positive gaps point to inflation pressure.
- Negative gaps mean slack.
- Potential output cannot be observed.
- Estimates differ and get revised.
Frequently asked questions
Who estimates the output gap?
Can the gap be measured exactly?
Is a negative gap always bad?
Further learning
- Gross Domestic Product
The actual output side.
- Inflation
What the gap helps predict.
- Central Bank
Who uses it most.
- Recession
When gaps turn negative.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- International Monetary Fund (Finance & Development). What Is the Output Gap? (Back to Basics) (opens in a new tab) Checked .
- Federal Reserve Bank of St. Louis (FRED). Real Potential Gross Domestic Product (GDPPOT) (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.