Output gap

What is the output gap

The output gap (also called the GDP gap) is the difference between what an economy actually produces and what it could produce at full, sustainable use of its labour and capital without pushing inflation up.

• Positive output gap: actual output is above potential. Demand is running hot, firms work above normal capacity, and inflation pressure tends to build.
• Negative output gap: actual output is below potential. There is spare capacity, such as idle workers and machines, and inflation pressure tends to ease.

Formal definition

Economists usually express the gap as a percentage of potential output:

Output gap = (actual real GDP − potential real GDP) ÷ potential real GDP, shown as a percentage

Actual real GDP is measured. Potential GDP cannot be observed and must be estimated. The common methods are:

• Statistical filters, such as the Hodrick–Prescott filter, which smooth GDP into a trend line.
• Production-function models, which estimate potential from labour supply, the capital stock and productivity.
• Multivariate models, which combine GDP data with inflation and unemployment.

Worked example (hypothetical)

Take an imaginary economy. Statisticians estimate its potential real GDP as P and record actual real GDP as Y.

• If Y is lower than P, the gap is negative. The economy is producing less than it could, and the central bank may see room to keep rates lower.
• If a credit boom later lifts Y above P, the gap turns positive. Capacity is stretched, and the central bank may see a case for tighter policy.

To turn this into a percentage, put your own P and Y into the formula above.

Edge cases experienced readers should know

• Revisions: GDP data and potential estimates are revised, sometimes enough to change the sign of the gap after the fact.
• End-point problem: statistical filters are least reliable for the most recent quarters, which are the quarters policymakers care about most.
• Supply shocks: an energy shock or a pandemic can lower potential output itself. A gap that looks negative may be smaller than it appears.
• Emerging markets: large informal sectors and changing structures make potential output harder to pin down. See emerging markets.

Where the term appears

• Central bank statements. Monetary policy statements discuss demand pressure, spare capacity and the inflation outlook when explaining rate decisions. The latest decision listed on the State Bank of Pakistan site is: SBP policy rate raised by 50 bps to 12% with effect from 27.10.2026 (MPC). Read the full statement to see how the committee describes the state of the economy.
• IMF and government reports. These often include output gap estimates in their assessments of individual countries.
• Economic news. The term appears around GDP releases and rate decisions. Markets may react to such news through currencies and indices, but no indicator reliably predicts price moves. Leveraged forex and CFD trading can lose money fast.

Trading platforms do not show the output gap as a number. It sits in the background of fundamental analysis.

Related terms

• Business cycle
• Disinflation and deflation
• Fiscal deficit and debt-to-GDP ratio
• Austerity
• Basis point
• Currency depreciation
• The full trading glossary

Frequently asked questions

What is the output gap in simple words?

It is how far an economy's actual output is above or below what it could sustainably produce.

Is the output gap the same as the GDP gap?

Yes. Both terms describe the difference between actual and potential GDP.

Why do central banks care about it?

A positive gap tends to add to inflation pressure, and a negative gap tends to ease it. That makes the gap one input into interest rate decisions.

Can the output gap be measured exactly?

No. Potential GDP is an estimate, so different methods give different gaps, and the estimates are often revised.

Does a negative output gap mean a recession?

Not necessarily. The economy can grow and still produce below its potential.