Which Output Gap do you pick?

The output gap shows the amount by which the actual output of an economy falls short of its potential output. With the GFC the ouput gap in the US was approximately 5% but I suppose it depends on which indicator you look at. Lewis Alexander of Nomura Securities in New York calculated the output gap using 3 different labour market indicators – see graph below:

1. Employment as a % of Population Gap
This went down from 63% in late 2007 to below 59% in 2009 and there has been little movement since this time.

2. The Unemployment Gap
The unemployment rate is 1.1% points above its estimated “natural rate” of 5.5%. This indicates a very small ouput gap

3. Short-Term Unemployment Gap
This refers to those who have been out of work for less than 6 months. Here you can see that the gap has just about been closed.

Output gap - USA

Which measure is right?

Deciding which measure to use involves determining why so many people have left the labour force. Labour participation – includes those in work or looking for work – is down from 66% to 63%. A third of this decrease is due to discouaged workers who have stopped looking for work. Furthermore there are those that have given up any chance of getting a job and therefore have permanently out of the labour force. This has become a major issue in the global economy as the longer you are unemployed the less chance you have of getting another job. In 2010 it was estimated that 18% of the long-term unemployed quit the workforce each month. By this year that rate had increased to 24%.

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