UK inflation in the 1970s and 1980s: the role of output gap mismeasurement

Quarterly Bulletin 2002 Q1
Published on 01 March 2002

By Edward Nelson and Kalin Nikolov

The amount of spare capacity in the economy is a vital input for policy-makers’ decisions on monetary policy. When expressed as a fraction of GDP, a frequently used summary statistic for the degree of spare capacity is the output gap—the percentage difference between actual output and the level of output consistent with sustainable full employment of resources. But the output gap available to policy-makers in real time is subject to two sources of error: both initial GDP estimates and the estimates of (unobserved) potential output may be revised subsequently.

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