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Why Central Banks Are Watching the Output Gap
Season 2
Episode 74
Published 9 hours ago
Description
Lucas and Luna unpack the output gap—the difference between actual GDP and potential GDP—and why it matters for interest rate decisions. They look at the European Central Bank's 2024-2025 tightening cycle and how the output gap influenced policy even as inflation surged. Specific numbers: the ECB's estimated output gap swung from -2.3% in 2020 to +0.8% by mid-2024, then back negative. The hosts explain how central banks use output gap estimates to set the neutral rate, and why the concept is controversial given measurement challenges. A concrete case: how Germany's weak manufacturing output in 2025 signaled a widening negative gap, putting pressure on the ECB to ease. No abstract theory—just how policymakers actually use this metric today.