How Central Banks Use the Output Gap to Set Policy

Monetary Policy Explained with Fexingo: Central Banks, Money Supply, and Interest Rates · Jul 11, 2026 · 8m · transcript

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…