What Do Today's GDP Numbers Tell Us About the Output Gap?

The Bureau of Economic Analysis today released its advanced estimates for fourth quarter Gross Domestic Product (GDP). The report showed that real GDP grew 1 percent between the third and fourth quarter of 2020, to about 2.5 percent below pre-COVID levels.

Importantly, this data comes from a period where the virus was spreading rapidly and cold weather limited the ability of adaptations like outdoor dining to facilitate in-person economic activity. The data also shows output before the enactment of the $940 billion Response & Relief Act and before the COVID vaccination campaign began in earnest (only 3 million first shots were administered by December 31).

Comparing actual estimated GDP to CBO's projections of potential GDP suggests an output gap of 2.8 percent — which is about $160 billion, or the equivalent of $630 billion on an annualized basis. In other words, the economy was producing 3 percent less than it could have sustainably produced absent the pandemic.

Comparing actual estimated GDP to CBO's pre-pandemic potential GDP projections yields an output gap of 3.6 percent — the equivalent of $810 billion on an annualized basis. This latter figure is likely an overestimate, since CBO's pre-pandemic figures assumed much higher rates of immigration and therefore population and labor force growth than what has occurred over the last year in light of the pandemic.

Since the final quarter of 2020, Congress has enacted a $940 billion COVID relief plan and over 25 million COVID vaccines have been administered — a number that is likely to increase as much as ten-fold (depending on demand) over the course of the year. As a result, we expect the 2021 output gap to be much smaller.

Previously, we estimated the end-of-year deal would close about three quarters of the 2021 output gap, leaving a relatively small remaining gap in 2021 but a significant shortfall in 2022 and 2023. We look forward to new data and CBO projections so we can update these estimates in the coming weeks.