Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium
Review this text, which graphically displays recessionary and
inflationary gaps and relates them to the labor market. The text also
discusses policy choices that address economic issues resulting from
these gaps.
Key Takeaways
- When the aggregate demand and short-run
aggregate supply curves intersect below potential output, the economy
has a recessionary gap. When they intersect above potential output, the
economy has an inflationary gap.
- Inflationary and recessionary gaps are closed as
the real wage returns to equilibrium, where the quantity of labor
demanded equals the quantity supplied. Because of nominal wage and price
stickiness, however, such an adjustment takes time.
- When the economy has a gap, policymakers can
choose to do nothing and let the economy return to potential output and
the natural level of employment on its own. A policy to take no action
to try to close a gap is a nonintervention policy.
- Alternatively, policymakers can choose to try to close a gap by using stabilization policy. Stabilization policy designed to increase real GDP is called expansionary policy. Stabilization policy designed to decrease real GDP is called contractionary policy.