The output gap measures the difference between an economy’s actual production (Actual GDP) and its potential output (Potential GDP). It is expressed as a percentage of the potential output.

This metric helps economists understand how well resources are being used and is a key indicator for predicting inflation:

• A positive output gap means the economy is operating above its long-term potential. This is often called “overheating” and can lead to rising inflation due to high demand.
• A negative output gap indicates economic slack, meaning there is underutilisation of labor and capital (e.g., high unemployment or idle factories).

The calculation is: (Actual GDP – Potential GDP) / Potential GDP x 100. This tool is vital for governments and central banks when creating macroeconomic policy.