There are three measures of economic growth: an income, output and expenditure measure (see macro core concept 1). Here we concentrate on the output measure (see handout). Real GDP, the real value of goods and services produced in any time period, gives us an annual growth rate currently forecast to be 2.4% (OBS) or 2.7% (CBI) for 2015. The range of forecasts gives us the fan chart (see above).

But what happens if output falls below the trend for a period, as it did in the latest recession (defined as a drop in real GDP over two successive quarters) of 2008-9? Then we observe an output gap (see extract) open up, and the question is, can we ever bridge the gap and return to the previous trend line?

Hysteresis may occur whereby aggregate supply moves permanently inwards. We depart from our production possibility frontier, and the possibilities also diminish. As unemployment increases, more people adjust to a lower standard of living. It becomes more socially acceptable to be or remain unemployed. After the labour market returns to normal, some unemployed people may remain economically inactive.

My summary of last year’s Uk growth performance is available here, and here you can find a graph of the US output gap since 1954.