To answer this question, economists define baseline values for unemployment and output known as the natural rate of unemployment and potential output. The concepts of output and employment gaps can be useful to economists in several ways. First, they often guide the inflation forecasts of Federal Reserve staff and other researchers and market participants. Second, some economists argue that employment gaps are a useful guide for policy aimed at achieving maximum sustainable employment and price stability. In this article, Roc Armenter briefly discusses two important examples of sophisticated measures of resource slack that are grounded in economic theory: the nonaccelerating inflation rate of unemployment and the output gap measure published quarterly by the Congressional Budget Office.

This article appeared in the First Quarter 2011 edition of Business Review.

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