Introduction to inflationary gap
An inflationary gap is known as a macroeconomic concept that covers the difference between the prevailing level of real gross domestic product and the GDP that would exist if an economy was working at full employment.
Understanding An Inflationary Gap
An inflationary gap endures when the demand for goods and services exceeds production due to higher overall employment levels, increased trade activities, or high government expenditure.
Against this backdrop, the real GDP can surpass the potential GDP, resulting in an inflationary gap. The inflationary gap is named because the comparable rise in real GDP causes an economy to develop its consumption, leading prices to climb in the long run.
The inflationary gap depicts the point in the business cycle when the economy is developing. Due to the higher number of funds obtainable within the economy, consumers are more likely to purchase goods and services. As demand for goods and services rises but production has not yet compensated for the shift, prices rise to restore market equilibrium.
When the potential GDP is higher than the real GDP, the gap is referred to as a deflationary gap. The other kind of output gap is the recessionary gap, which represents an economy operating below its full-employment equilibrium.
Significance Of Inflationary Gap
Effect on Income and Prices - The importance of the inflationary gap depends on its effect on the national income and prices. When an inflationary gap endures at full employment, it raises the money income of the people, but the output cannot be increased because of full employment. Hence, the inflationary gap directly leads to a rise in prices.
Non-Monetary Inflation - Keynes’ emphasis on the flow of expenditures as the cause of demand-pull inflation leads to the result that a society can have non-monetary inflation. This is quite the opposite of the view held by the quantity theorists who believed inflation is because of the excessive growth of money stock.
In Keynes’ analysis, the effect of this extreme growth of money supply may be uncertain because it will cause an inflationary increase in prices indirectly through its impact first on the rate of interest and, in turn, aggregate spending.
Anti-Inflationary Policies- The inflationary gap manages the monetary and fiscal authorities to adopt suitable anti-inflationary measures to restrain inflationary pressures. These measures intend to affect the propensities to consume, save, and invest, which together determine the general price level.
