T he output gap is the difference between the economy’s actual output and the level of production it can achieve with existing labour, capital, and technology without putting sustained upward pressure on inflation . The output gap is also referred to as spare capacity or excess capacity. The gap is positive when actual output exceeds the economy's potential and negative when actual output is below potential output. A positive output gap is also referred to as excess demand and a negative output gap is referred to as excess supply. Pressure on output must be sustainable When spending in the economy is high in relation to capacity, this tends to put upward pressure on prices. Conversely, a low rate of spending tends to put downward pressure on prices. This relationship can also be expressed in the reverse manner—if the rate of inflation begins to increase, it is typically a sign that spending levels are approaching the economy’s level of potential output and that output growth is not sustainable. Conversely, if the rate of inflation is consistently
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