Output gap

GDP gap

The GDP gap or the output gap is the difference between potential GDP and actual GDP or actual output. The calculation for the output gap is Y-Y* where Y is potential output and Y* is actual output or the natural level of output. If this calculation yields a positive number it is called a recessionary gap and indicates an economy in expansion; if the calculation yields a negative number it is called a expansionary gap and indicates an economy in recession.

The percentage GDP gap is the potential GDP minus the actual GDP divided by the actual GDP. (potential GDP - actual GDP)/actual GDP.

GDP Gap & Unemployment - Okun's Law

Okun's Law is based on regression analysis of US data that shows a correlation between unemployment and GDP. Okun's law can be stated as: For every 2% increase in potential GDP, the actual employment rate exceeds the natural rate of employment by 1% of the potential GDP.

%Output gap = -β x %Cyclical unemployment

This can also be expressed as:

(Y-Y*) / Y*= - β(u-ū)

where:

  • Y is actual output
  • Y* is potential output
  • u is actual unemployment
  • ū is the natural rate of unemployment
  • β is a constant derived from regression show the link between deviations from natural output & natural unemployment.

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