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

CONTROLLING AN INFLATIONARY GAP

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.