US & World Economies Economic Terms What Is a Recessionary Gap? Contractionary Gap Explained in Less Than 4 Minutes By Ann Logue Ann Logue Ann Logue is the author of "Day Trading for Dummies," "Hedge Funds for Dummies," and "Socially Responsible Investing for Dummies." She has over two decades of experience covering investing, business, and economics for a range of outlets, including Nordea Markets, Gerstein Fisher Asset Management, and The Balance. learn about our editorial policies Updated on April 26, 2022 Reviewed by Erika Rasure Reviewed by Erika Rasure Erika Rasure, is the Founder of Crypto Goddess, the first learning community curated for women to learn how to invest their money—and themselves—in crypto, blockchain, and the future of finance and digital assets. She is a financial therapist and is globally-recognized as a leading personal finance and cryptocurrency subject matter expert and educator. learn about our financial review board In This Article View All In This Article Definition and Example of a Recessionary Gap How a Recessionary Gap Works What It Means for Individual Investors Photo: VioNettaStock / Getty Images Definition A recessionary gap is the difference between the amount of goods and services produced at full employment and during a recession when employment is lower. A recessionary gap is the difference between the amount of goods and services produced at full employment and during a recession when employment is lower. This production is measured as the gross domestic product (GDP). This gap is a way that economists measure the lost potential of an economy operating in a recession. They estimate what the economy could produce if it were at capacity, then subtract what it is producing now to find the shortfall. Understanding recessionary gaps can help you better understand the effects of recessions and other types of financial news on your investment portfolio. Definition and Example of a Recessionary Gap A recessionary gap is the reduced output generated when a country's real GDP is lower than its GDP would be at capacity, which is measured as full employment. At this point, everyone who wants a job would have one, with an allowance for people who have been fired for cause or who are entering the workforce after school or a break. Economists usually consider full employment to be around a 4% unemployment rate. 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. Note Recessionary gaps close when the economy returns to full employment. This happens when there are enough job opportunities that the quantity of labor demanded equals the quantity supplied. Economists say that at this point, real wages return to equilibrium. 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. Note The worse the recession, the greater the recessionary gap, and the more companies—and possibly their stock prices—are affected by the decline. 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. Key Takeaways The difference in output between when the economy is in full output and when it is in a recession is the recessionary gap.The size of the gap will depend on many factors, including the structure of the economy and the reason for the recession.Governments use interest rate cuts and stimulus spending to offset recessionary gaps. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Robert E. Hall, Massachusetts Institute of Technology. “Why Is the Unemployment Rate so High at Full Employment?” Page 370. Accessed Dec. 12, 2021 U.S. Bureau of Labor Statistics. “Job Market Remains Tight in 2019, as the Unemployment Rate Falls to Its Lowest Level Since 1969.” Accessed Dec. 12, 2021. Bureau of Economic Analysis. “Gross Domestic Product, Fourth Quarter and Year 2019 (Second Estimate).” Accessed Dec. 12, 2021. U.S. Bureau of Labor Statistics. “Civilian Unemployment Rate.” Accessed Dec. 12, 2021. Bureau of Economic Analysis. “Gross Domestic Product, Fourth Quarter and Year 2020 (Second Estimate).” Accessed Dec. 12, 2021.