What Is an Inflationary Gap?

An inflationary gap measures the difference between the current level of 澳洲幸运5官方开奖结果体彩网:real gross domestic product (GDP) and the GDP that would exist if an economy was operating at 澳洲幸运5官方开奖结果体彩网:full employment.

Understanding an Inflationary Gap

An inflationary gap exists when the demand for goods and services exceeds production due to higher levels of employment, increased trade activities, or elevated government expenditure. 澳🦄洲幸运5官方开奖结果体彩网:The real GDP can exceed the potential GDP, resulting in an inflationary gap:

$\begin{aligned}&\text{Inflationary Gap} = \text{Actual GDP} - \text{Anticipated GDP} \\\end{aligned}$​Inflationary Gap=Actual GDP−Anticipated GDP​

The inflationary gap represents the point in the 澳洲幸运5官方开奖结果体彩网:business cycle when the economy expands as consumers purchase more goods and services. As demand increases but production lags, prices rise to restore market 澳洲幸运5官方开奖结果体彩网:equilibrium.

The real GDP must be higher than the potential GDP for the gap to be considered inflationary. When the potential GDP is higher than the real GDP, the gap is instead referred to as a 澳洲幸运5官方开奖结果体彩网:deflationary gap.

Calculating Real Gross Domestic Product (GDP)

GDP measures the monetary value of final goods and services produced in a given period and bought by the final user within an economy. GDP is composed of goods and services for sale in the market and includes some nonmarket output, such as defense or education services provided by the government. 

According to 澳洲幸运5官方开奖结果体彩网:macroeconomic theory, the goods market determines the real GDP, shown in the following relationship. To calculate real GDP, first compute the 澳洲幸运5官方开奖结果体彩网:nominal GDP:

$\begin{aligned}&\text{Y} = \text{C} + \text{I} + \text{G} + \text{NX} \\&\textbf{where:} \\&\text{Y} = \text{Nominal GDP} \\&\text{C} = \text{Consumption expenditure} \\&\text{I} = \text{Investment} \\&\text{G} = \text{Government expenditure} \\&\text{NX} = \text{Net exports} \\\end{aligned}$​Y=C+I+G+NXwhere:Y=Nominal GDPC=Consumption expenditureI=InvestmentG=Government expenditureNX=Net exports​

Then, the real GDP = Y/D, where D is the 澳洲幸运5官方开奖结果体彩网:GDP deflator, which takes inflation into effect over time.

An increase in consumption expenditure, investments, government expenditure, or net exports causes real GDP to rise in the short run. Real GDP provides a measure of economic growth while compensating for the effects of 澳洲幸运5官方开奖结果体彩网:inflation or 澳洲幸运5官方开奖结果体彩网:deflation. This accounts for the difference between actual🔴 economic growth and a simple shift in the prices of goods ꦕor services within the economy.

Fiscal and Monetary Policy to🐎 Manage the Inflationary Gap

A government may use 澳洲幸运5官方开奖结果体彩网:fiscal policy to help reduce an inflationary gap by decreasing the number of funds circulating in the economy. This is accomplished through reductions in government spending, tax increases, bond an🎀d securities issues, and transfer pay♈ment reductions.

These adjustments to the fiscal conditions within the economy can restore 澳洲幸运5官方开奖结果体彩网:economic equilibrium. As the amount of money in circulation decreases,𒁃 the overall demand for goods and services declines, reducing inflatio🍸n.

Central banks also have tools at their disposal to combat inflationary activity. When the 澳洲幸运5官方开奖结果体彩网:Federal Reserve (Fed) raises 澳洲幸运5官方开奖结果体彩网:interest rates, borrowing funds is more expensive.

澳洲幸运5官方开奖结果体彩网:Tight monetary policy can lower the money available to most consumers, triggering less demand and inflation retreats. Once equilibrium is reached, the Fed or other 澳洲幸运5官方开奖结果体彩网:central bank can shift interest rates accordingly.

The Bottom Line

An inflationary gap measures the difference between the cur𝄹rent real GDP and the potential GDP where an economy operates at full employment. The current real GDP is higher than the potential GDP for the gap to be inflationary. Governments impose policies to reduce an inflationary gap, such as reductions in government spending and tax and interest rate increases.