Definition
Output Gap
The output gap is the difference between an economy's actual output and its potential (full-capacity) output, signalling whether it is overheating or underperforming.
A positive output gap (actual above potential) means the economy is running hot, raising inflation risk; a negative gap signals slack, weak demand and disinflation. Central banks aim to close the gap.
The RBI and economists estimate India's output gap to gauge how much room there is to grow without stoking inflation. Because potential output is unobservable, output-gap estimates are uncertain and frequently revised, but they remain central to monetary-policy judgement.
Related terms
- Phillips CurveThe Phillips curve describes an inverse short-run relationship between unemployment and inflation: lower unemployment tends to come with higher inflation, and vice versa.
- NAIRUNAIRU is the non-accelerating inflation rate of unemployment, the jobless rate at which inflation stays stable; below it, inflation tends to rise.
- Potential OutputPotential output is the maximum sustainable level of production an economy can achieve at full employment of resources without accelerating inflation.
- Okun's LawOkun's law is the empirical relationship that each percentage-point rise in unemployment above its natural rate is associated with a roughly 2% fall in real GDP below potential.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.