Output gap and the business cycle - A good simple measure

 

A good way to look at where we are in the economy is to compare the real GDP against the real potential GDP. The difference between actual and potential is the output gap. An economy that is showing GDP above potential will be overheating and likely see inflation. GDP that is below potential and turning negative will indicate a slowing economy and a decline in inflation. 

The post GFC period showed a lower potential GDP, but actual real GDP posted numbers slightly higher than potential. Real GDP was generally lower than in the past and inflation was muted. 

The pandemic gave the US economy the biggest jolt down and then up ever seen. These dislocation from potential GDP played havoc with pricing decisions. We are now seeing real GDP fall below potential on a year-over-year change.

The quarter-over-quarter numbers shows the huge distortion from the pandemic in a more extreme form. We are now seeing numbers below potential and negative. There has never been a period where there has been a strong shift to negative real GDP without there being a recession. The data speak.