Recessionary Gaps

Definition

A recessionary gap refers to the difference between the actual level of real GDP and the potential level of real GDP during an economic recession. It represents the shortfall in economic output compared to the economy's full productive capacity.

5 Must Know Facts For Your Next Test

1. Recessionary gaps occur when actual GDP falls below potential GDP, indicating underutilized resources and economic slack in the economy.
2. The presence of a recessionary gap signals weak aggregate demand, leading to high unemployment, low business investment, and slow economic growth.
3. Governments and central banks often implement expansionary fiscal and monetary policies to close recessionary gaps and stimulate the economy.
4. Closing a recessionary gap is a key objective of macroeconomic stabilization policies, as it helps restore full employment and potential output.
5. The size of the recessionary gap provides policymakers with a measure of the severity of the economic downturn and the extent of resources that need to be mobilized to promote recovery.

Review Questions

• Explain how a recessionary gap is related to the concepts of actual GDP and potential GDP.
  • A recessionary gap arises when the actual level of real GDP falls short of the economy's potential GDP, which represents the maximum sustainable level of output when all resources are fully employed. The difference between actual GDP and potential GDP is the recessionary gap, indicating underutilized resources and economic slack in the economy. The presence of a recessionary gap signals weak aggregate demand, leading to high unemployment, low business investment, and slow economic growth.
• Describe the role of government and central bank policies in addressing a recessionary gap.
  • Governments and central banks often implement expansionary fiscal and monetary policies to close recessionary gaps and stimulate the economy. Expansionary fiscal policies, such as increased government spending or tax cuts, can boost aggregate demand and help move the economy towards its potential output. Expansionary monetary policies, like lowering interest rates or increasing the money supply, can also stimulate investment and consumption, contributing to the closure of the recessionary gap. Closing a recessionary gap is a key objective of macroeconomic stabilization policies, as it helps restore full employment and potential output.
• Analyze how the size of the recessionary gap can inform policymakers' decisions and actions.
  • The size of the recessionary gap provides policymakers with a measure of the severity of the economic downturn and the extent of resources that need to be mobilized to promote recovery. A larger recessionary gap indicates a more significant shortfall in economic output compared to the economy's full productive capacity, requiring more substantial policy interventions to stimulate aggregate demand and close the gap. Policymakers can use the size of the recessionary gap to determine the appropriate scale and timing of fiscal and monetary policies, as well as to monitor the effectiveness of these policies in restoring the economy to its potential level of output.

Related terms

Potential GDP: The maximum sustainable level of real GDP that an economy can produce when all resources are fully employed.

Actual GDP: The total market value of all final goods and services produced within a country during a given time period.

Output Gap: The difference between the actual level of real GDP and the potential level of real GDP, which can be either positive (inflationary gap) or negative (recessionary gap).