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Minding the Output Gap: What Is Potential GDP and Why Does It Matter?


Abstract: Potential output is an estimate of what the economy could produce. Actual output is what the economy does produce. If actual is below potential -- a negative output gap -- there is "slack" in the economy. If actual is above potential -- a positive output gap -- resources are fully employed, or perhaps overutilized. This issue of Page One Economics explains how the output gap is useful for checking the health of the economy. It also points out how errors in the estimation of potential real GDP can reduce the effectiveness of policy.

Keywords: GDP; business cycle; federal funds rate; fomc; full employment; inflation; real GDP; potential output; stimulus;

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Provider: Federal Reserve Bank of St. Louis

Part of Series: Page One Economics Newsletter

Publication Date: 2021-05-03