TMA 3 – DD209 Norbert Lukacsi P.I. B3584727 Describe, including a Phillips curve diagram, how and why the output gap between equilibrium and actual output is used by policymakers to target inflation. With reference to the output gap and the extract from Minutes of the Monetary Policy Committee shown below, explain the Bank of England’s October 2012 decision to hold interest rates constant at 0.5% and maintain quantitative easing (referred to as asset purchases in the extract).

The output gap can be defined as the difference between the actual level of production and the potential output of an economy. The output gap is closely related to targeting inflation. Along with measuring the output gap of an economy, policy makers are also interested in the measure of the growth rate of the economy’s potential output. The variable is one of the major factors for improving living standards. It is also important for conducting monetary policy as it evolves. An example would be the potential growth of the output in the economy as it can directly affect the aggregate demand and inflation. It has the influence on Income expectations and asset prices. The output gap of course is interlinked with the Labour market and its influence over inflation, as well as the general overall productivity (output) and wages. Therefore, the following essay will focus on the output gap between equilibrium and actual output used by policymakers to target inflation. It will reference the monetary policy meeting of the Bank of England in October 2012. One of the main factors which have direct influence over inflation is the Labour market. The Labour markets can control the level of output for an economy. The Labour market is generally thought of where buyers and sellers exchange goods or services, normally in the form of wages in return for labour (Howells and Santos, p.289). This would be between an employer and a worker.