Should we be worried about deflation, or will inflation take off again? One reason why many believe inflation will remain subdued is the belief that there is plenty of spare capacity in Western economies. In other words, there is a huge, negative output gap – or gulf between potential and actual GDP – thanks to the brutal recession that began in 2008.
This implies that there is no prospect of demand exceeding supply, and hence inflation becoming entrenched, any time soon: the economy can gradually grow into the capacity that was left idle.
But measuring the gap is more art [...]
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