At full employment, the people in a country produce the maximum sustainable amount of goods and services possible. When the economy slows and enters a recession, the amount of goods and services produced falls, and unemployment increases. The difference between the two states is the recessionary gap.
Alternate names: Contractionary gap, negative output gap
The U.S. had an unemployment rate of 3.5% at the end of 2019, very close to full unemployment and the lowest unemployment rate since 1969. GDP then was $21.73 trillion. Thanks in large part to global events in 2020, unemployment at the end of that year was 6.7%, after reaching a high of 14.8% in April. GDP for 2020 was $20.93 trillion. The negative output gap caused by the increase in unemployment was significant: $800 billion, or $21.73 trillion minus $20.93 trillion.
How a Recessionary Gap Works
A recessionary, or contractionary, gap is a way to measure and explain in dollar terms the economic shortfall that occurs in a recession. The effect of a change in unemployment on the amount of goods and services produced may be different in different countries or due to varied causes for the recession. Economists study such gaps to give planners and policymakers information that they can use to manage the economy. Regardless, economies are going to cycle in and out of recession but if the change in output is small, then consumers will be less harmed.
What It Means for Individual Investors
A recessionary gap will occur when unemployment increases. That’s a given. The effect on output will lead to revenue declines for some companies across a variety of industries. The higher the unemployment rate and larger the decline in output, the more pressure there will be on the government to respond. The usual way to do this is to lower interest rates, which can help the value of both stocks and bonds. Another way to address a decline in output is to increase government spending, which can lead to increased output but may also propel increased interest rates.
