What is a recessionary gap?

A recessionary gap occurs when the actual economic output of a country falls short of its potential output. Potential output represents the maximum level of goods and services an economy can produce when operating at full efficiency, including fully utilizing resources such as labor and capital. When there is a recessionary gap, it typically indicates that there are underutilized resources, resulting in higher unemployment rates and lower levels of income and spending in the economy.

This situation often arises during economic downturns when aggregate demand decreases, leading to reduced production and job losses. Understanding the concept of a recessionary gap is crucial for policymakers, as it highlights the need for interventions such as fiscal and monetary policies to stimulate economic growth and bring actual output closer to potential output.