Menzie Chinn wrote about various ways to estimate potential GDP. It becomes perplexing when an estimation shows that the output gap could be zero. Why? Because there are such weak inflation pressures...
“That seems implausible to me, but then, so too does a nearly zero gap, given the lagging inflation rate.” – Menzie Chinn
The gap can be closed with weak inflation pressures.
Just hold down labor power, spread underemployment among more people, reduce labor share by 5%, mute investment and increase inequality. You weaken consumer power for more people.
Now the real problem in understanding low inflation at a zero gap is thinking there is still much more spare capacity with so much underemployment. That is not good thinking. Underemployment does not necessarily imply spare capacity. It could also imply economically marginalized people working in underemployed jobs, which holds down wage inflation.
The economy has a balance for the number of labor hours needed for the concentrations of consumer wealth in an economy. The higher concentrations of wealth that we see now imply fewer labor hours in balance. We have seen labor hours peak at the same level for two decades now. The result is that many people will be cut out (marginalized) from the economy because they are not needed in the balance.
So what appears as spare capacity is really unneeded capacity that will never be utilized.
How many people have been cut out of the economy by rising inequality? We will eventually know as the Fed rate seeks normalization.