The output gap is the difference between an economy’s actual output, otherwise known as gross domestic product (GDP), and what it would be if that country’s industries were working flat out. The bigger the gap, the less scope businesses have to raise prices.
This means less chance of inflation picking up – indeed, prices could actually fall. But measuring output gaps can be tricky. That’s because in a deep recession, many firms cut costs by mothballing or completely shutting down some of their less profitable spare capacity. This curbs downward price pressures.
When the economy recovers, there may be less slack available to produce extra goods than had been expected. So inflation could make a faster comeback than forecast.