Output gap

Actual output less potential output. A negative gap means spare capacity and downward pressure on inflation; a positive one means the economy is running above what it can sustain.

Where you will meet it

Output gap appears in 3 learning outcomes on the CFA syllabus. A few of them:

• Explain how each stage of the business cycle shapes policy and short-term rates, the steepness of the yield curve, and how bonds of shorter and longer maturity perform against each other
  CFA Level II · Portfolio Construction

  “A common guide to policy is the Taylor rule, which sets the policy rate at i = neutral real rate + current inflation + 0.5 × (inflation − target) + 0.5 × output gap.”

• Explain why equity and fixed income investors care about potential GDP and how fast it grows
  CFA Level II · Economics

  “For bond investors, the gap between actual and potential output signals inflation pressure: growth above potential opens a positive output gap, pushing inflation and policy rates up and bond prices down.”

• Explain how central bank and government budget policy influence the course of the business cycle
  CFA Level III · Asset Allocation

  “A common benchmark is the Taylor rule: target policy rate = neutral real rate + expected inflation + 0.5 × (output gap) + 0.5 × (inflation − target).”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with O · Glossary