Tag Archives: potential supply

Potential supply, the output gap and inflation

Stephen Millard

Potential supply matters!  If an economy is producing less output than it could, then there are resources that are being wasted.  And when these resources are human – that is unemployment – this carries an additional social cost.  But why, specifically, should it matter for an inflation-targeting central bank?  Presumably, because it is a good indicator of inflationary pressure!  The trouble is that there are good reasons to think that this is not actually the case.  And economic theory suggests there is a much better measure of inflationary pressure we can use.

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Filed under Macroeconomics, Monetary Policy