Output Gap

The output gap is the difference between an economy's actual gross domestic product and its estimated potential output, used as a key indicator of where an economy sits in the business cycle. A positive, or inflationary, gap occurs when actual output exceeds potential output and suggests demand is outpacing supply, while a negative, or recessionary, gap occurs when actual output falls short and can point toward deflationary pressure. The measure is widely used in macroeconomic policy, including for monitoring compliance with European Union fiscal rules, though economists caution that potential output cannot be directly observed and must be estimated from historical data, which can introduce systematic error.