Minding the gap

The output gap is defined as ‘the difference between actual and potential output.’ When actual output exceeds potential output, the gap is positive. When actual output is less than potential output, the gap is negative. The size of the output gap traces the course of the business cycle. In the current recession, the output gap is negative in all major economies. The worry in recent months has been that a persistent large negative gap could lead to a downward deflationary spiral. Evidence is emerging, however, that the recession may be bottoming out and the danger of deflation easing. But just how big is the current negative output gap? As the article below from The Economist states, “Estimating how big the output gap is, and how much of a deflationary threat it still poses, is not easy.”

So how is the output gap measured in practice? How do we measure ‘potential output’? The two articles consider this issue of measurement and the relationship between the output gap and the rate of inflation. The last two links are to data sources giving estimates of the output gap. The first is from the European Commission and the second is from the OECD. As you will see, there are differences in their estimates.

Put out: Uncertainty over the size of the output gap complicates the task of central banks The Economist (2/7/09)
How big is the output gap? FRBSF Economic Letter (12/6/09)

See also:
Box 1.3.2 on page 31 and Table 13 on page 140 of European Economy: Economic Forecast, Spring 2009 European Commission, Economic and Financial Affairs (From the above link, click on the little ‘en’ symbol.)

and: Table 10 from OECD Economic Outlook No. 85, June 2009 OECD (From the above link, click on ‘Demand and output’. The first 10 tables then download as an Excel file.)

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