How Central Banks Use the Output Gap to Set Policy

Episode 105 of Monetary Policy Explained with Fexingo dives into the output gap — the difference between actual and potential GDP — and how central bankers use it to calibrate interest rates. Lucas and Luna break down the concept using the U.S. economy in mid-2026, where estimates suggest the output gap has narrowed to roughly 0.5 percent of GDP after a period of above-trend growth. They discuss how the Federal Reserve and other central banks rely on output gap estimates from institutions like the Congressional Budget Office, the uncertainty around measuring potential output, and why a small positive gap can trigger rate hikes even if inflation looks contained. The episode also touches on how the output gap interacts with concepts like the Taylor Rule and r-star, without rehashing prior episodes. Perfect for listeners who want to understand the real-time data points that shape monetary policy decisions. #OutputGap #MonetaryPolicy #CentralBanks #FederalReserve #PotentialGDP #TaylorRule #RStar #CBOMeasurements #RateHikes #EconomicGrowth #Inflation #GDP #BusinessCycle #Economics #FexingoBusiness #BusinessPodcast #MonetaryPolicyExplained #MacroEconomics Keep every episode free: buymeacoffee.com/fexingo