Potential GDP
The level of real GDP an economy can produce when operating at full employment without accelerating inflation.
What is Potential GDP?
Potential GDP represents the maximum sustainable level of output an economy can achieve when all resources — labor, capital, and technology — are employed at their normal rates, without generating accelerating inflation. When actual GDP exceeds potential GDP, the economy is said to have a positive output gap, often leading to inflation. When actual GDP falls below potential, a negative output gap exists, typically accompanied by unemployment above its natural rate. The Congressional Budget Office (CBO) estimates US potential GDP and uses it as a benchmark for fiscal and monetary policy analysis.
Example
During 2021–2022, the US economy recovered rapidly from the COVID-19 recession. By mid-2022, actual GDP had surpassed the CBO's estimate of potential GDP, creating a positive output gap. This helped explain why inflation surged — demand was exceeding the economy's sustainable productive capacity — and why the Federal Reserve raised interest rates aggressively to close the gap.