The “Output Gap” and Excess Labor Employment

The debate surrounding the current status of monetarypolicy and inflation has appealed to the existence of anoutput gap that will prevent the resurgence of substantialinflation. This paper presents evidence that the expansionin the late 1990s was unusual and should not be used asa basis for benchmarking the output gap at zero. In particular,there was an unusual psychology that prevailedin the late 1990s and 2000 that led to excessive capitalspending and hiring. If policymakers overestimate themagnitude of the output gap by overestimating excesslabor supply, they run the risk of making timing errors inthe implementation of economic policy.JEL Classification E240, J210