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
AN INFLATIONARY GAP
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.
Policy: Higher interest rates to curb consumer demand
Policy: A rise in the burden of taxation to reduce real disposable
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.
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.