how the potential output is measured can be problematic in fact there isn t just one way to do so analysts and economists may use different filters or models to do so for instance some experts may compute the potential output as the trend output while others consider it as the trend growth 1
another limitation to the output gap lies in how intertwined relationships are within the economy for example a less active workforce will lead to a drop in output similarly distressed small businesses and corporations and tighter lending standards during tough economic times can also have a big impact on the potential output 1it provides a picture of how the economy is doing policymakers are able to use output gap to help make decisions consumers and investors can make informed decisions about their finances and investments output gap is hard to measure because we can t observe potential output there is no uniform way to measure potential output potential output relies heavily on relationships that are intertwined in the economy real world example of an output gapthe actual gdp in the u s was 21 48 trillion through the fourth quarter of 2020 according to the bureau of economic analysis 5 according to the federal reserve bank of st louis the potential gdp for the u s in the fourth quarter of 2020 was 19 41 trillion meaning the u s had a positive output gap of about 10 7 projected gdp subtracted from actual gdp projected gdp 6keep in mind that this calculation is just one estimate of potential gdp in the u s other analysts may have different estimates but the consensus is that the u s was facing a positive output gap in 2020 not surprisingly the federal reserve bank in the u s has consistently been raising interest rates since 2016 in part in response to the positive gap rates were at less than 1 in 2016 and hit as high as 1 25 in the early part of 2020 the global financial crisis though forced the fed to drop rates back down below 1 in mid march 2020 7potential output faqspotential output is what an economy can produce if it operates at full employment gdp this is generally the highest level if and when the economy is doing very well unlike actual output which is what currently happens potential output cannot be measured and therefore relies on estimation an economy s output gap can deviate from its potential in one of two ways a positive output indicates the economy is performing well above expectations that s because the actual output is higher than its potential it may also be negative when the output is below full capacity governments may find that reducing government spending as well as cutting down transfer payments and their bond and security issues can help reduce an inflationary output gap 