The output gap problem

If you wanted to place the Great Recession into perspective, just look at the output gap. The output gap measures the difference between current GDP and trend. In a recession you will fall below trend, but the expectation is that the economy will grow faster in a recovery and then close the gap. This is not going to happen with the US economy anytime soon. We are still years off of getting back to the trend-line.

It is hard to expect higher interest rates or expect inflation to increase significantly if there is a large output gap. It is hard to talk about unemployment falling much further if there is no closing of the output gap. Discussions of tax revenue shortfalls will continue as long as there is an out put gap. The output gap will drive thinking about the potential for reflation of assets.