Inflation and Output Gap Forecasts

The output gap is an important monetary policy variable used to gauge inflationary pressures in the economy. Under the inflation targeting regime, central banks shape their monetary policy in light of inflation forecasts for the future period rather than the actual inflation.

Accordingly, a positive output gap points to demand-pull inflationary pressure as the economy works at over its capacity due to excess demand. 

On the other hand, a negative output gap points to disinflationary pressure stemming from excess supply or excess capacity in the economy due to weak demand.