GDP Output Gap Vs. Inflation

The GDP Output Gap is a very nice indicator for inflation. It is a leading indicator for inflation and is based on the potential real GDP.

Potential gross domestic product (GDP) is defined in the OECD’s Economic Outlook publication as the level of output that an economy can produce at a constant inflation rate. Although an economy can temporarily produce more than its potential level of output, that comes at the cost of rising inflation.

Potential GDP = (natural rate of employment) ÷ (actual rate of employment) * (actual GDP)

So if you see that the output gap (potential GDP – current GDP) is narrowing, you should begin to see inflation. On the chart below we see that the output gap is narrowing and I expect inflation to start showing up in 2017.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=4ks8

Let’s take a look at the 1980’s. You can clearly see that inflation appears when the red line goes above the blue line.

China’s Power Consumption/Output Vs. Chinese GDP

China becomes increasingly important in our world. It’s advisable to follow China’s GDP growth because everything depends on it. If China does well, the whole Asian continent will do well, commodities like iron ore, gold, silver, copper will go up. The Australian economy and its currency depend on China. Emerging markets like Vietnam, Taiwan, Thailand, etc… will do good.

To predict Chinese GDP growth, we can look at the monthly Chinese power output/consumption numbers because there is a clear correlation here.

If the yoy Chinese power consumption (Chart 1: red line) goes up, the GDP growth (Chart 2) goes up.

Chart 1: China power consumption growth

Chart 2: Power output growth Vs. GDP growth