What is GDP Gap?
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A GDP gap is the difference between the actual gross domestic product (GDP) and the potential GDP of an economy as represented by the long-term trend. A negative GDP gap represents the forfeited output of a country's economy resulting from the failure to create sufficient jobs for all those willing to work. A large positive GDP gap, on the other hand, generally signifies that an economy is overheated and at risk of high inflation.The difference between real GDP and potential GDP is also known as the output gap.
Definition
The GDP gap refers to the difference between actual Gross Domestic Product (GDP) and the potential GDP of an economy. Potential GDP represents the long-term trend output of an economy when it is operating at full employment and optimal resource utilization. A negative GDP gap indicates that the economy is not creating enough jobs for all willing workers, resulting in lost output. Conversely, a positive GDP gap usually suggests an overheating economy, which may face high inflation risks. The gap between actual GDP and potential GDP is also known as the output gap.
Origin
The concept of the GDP gap originated from economists' studies of economic cycles, particularly under the influence of Keynesian economics. In the mid-20th century, economists began focusing on the difference between economic output and its potential level to better understand economic fluctuations and policy impacts.
Categories and Features
The GDP gap can be categorized into positive and negative gaps. A positive gap indicates economic activity exceeding potential levels, potentially leading to inflationary pressures. A negative gap indicates economic activity below potential levels, often accompanied by high unemployment and low inflation. Identifying and analyzing the GDP gap helps in formulating monetary and fiscal policies to achieve economic stability.
Case Studies
During the 2008 global financial crisis, the United States experienced a significant negative GDP gap, with actual GDP far below potential levels, leading to high unemployment and recession. In response, the Federal Reserve implemented quantitative easing policies to stimulate economic recovery. Conversely, during the late 1990s tech bubble, the U.S. experienced a positive GDP gap, with economic growth exceeding potential levels, leading to increased inflationary pressures.
Common Issues
Investors often misunderstand the short-term and long-term impacts of the GDP gap concept. In the short term, a negative gap may require stimulative policies, while a positive gap may necessitate contractionary policies. However, over-reliance on a single indicator can lead to policy errors, so it should be analyzed in conjunction with other economic indicators.
