Question

An inflationary (or expansionary) gap causes what effect?

Answer 1

Inflationary gap is the difference created when the real GDP of an economy is higher than that of potential gdp. Aggregate demand is higher than that of produced goods and service so it leads to increase in price level. Government and central bank can use contractionary fiscal policy and monetary policy to solve the problem.

Deflationary gap is occur when the real GDP is less than potential gdp. Means the front rate is far behind the potential growth rate this leads to increase in unemployment and decrease in price level. Fiscal and monetary authority can use expansionary policy to make the economy push to potential level.