What is one consequence of an economy operating below potential output?

When an economy operates below its potential output, it is typically producing less than it is capable of, which often leads to a rise in unemployment. This situation arises because businesses are not producing at full capacity, which often triggers a reduction in workforce needs. In other words, if an economy is not utilizing its resources—like labor and capital—effectively, this can result in layoffs or slower hiring processes, thereby increasing the unemployment rate.

This concept is grounded in the relationship between output and employment, as described by Okun's law, which posits that there is an inverse relationship between unemployment and economic output. When the economy is below its potential, many workers who are willing and able to work remain unemployed, highlighting one of the key consequences of operating below potential.

In contrast, increased interest rates, high tax revenue, and higher inflation rates typically occur under different economic conditions—such as a growing economy with a tight labor market, leading to rising wages and consumer spending, which can push inflation higher.