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Inflationary Gaps


When aggregate demand exceeds an economy's productive potential there is an inflationary gap. We tend to see rising inflation and a worsening trade situation at these times


The government may use monetary and or fiscal policy to help reduce the size of the inflationary gap. An improvement in the supply-side performance of the economy would also achieve this.

  • Monetary Policy: Higher interest rates to curb consumer demand
  • Fiscal Policy: A rise in the burden of taxation to reduce real disposable incomes
  • Supply-side Policy: Measures to increase productivity and efficiency. This leads to a rise in aggregate supply and reduces the amount of excess demand in the long run.


Inflationary gaps can arise when the economy has grown for a long time on the back of a high level of aggregate demand. Total spending may rise faster than the economy's ability to supply goods and services. As a result, actual GDP may exceed potential GDP leading to a positive output gap in the economy.



E-mail Steve Margetts