What Is the Real Economic Growth Rate?
The real economic growth rate, or real GDP growth rate, measures economic growth, as expressed by gross domestic product (GDP), from one period to another, adjusted for inflation or deflation. In other words, it reveals changes in the value of all goods and services produced by an economy—theeconomic output of a country—while accounting for price fluctuations.
Key Takeaways
- The real economic growth rate removes inflation in its measurement of economic growth,unlike the nominal GDP growth rate.
- Real GDP can be calculated by adjusting nominal GDP by inflation.
- Real GDP can also be measured as a dollar or a percentage by calculating changes in real GDP from one period to the next.
- Real economic growth is used by policymakers todetermine growth over time by comparing GDP from different time periods.
- Real economic growth is also used to compare the growth rates of similar economies with different rates of inflation.
Understanding the Real Economic Growth Rate
The real economic growth rate is expressed as a percentage that shows the rate of changeina country's GDP, typically from one year to the next. Anothereconomic growth measure is the gross national product (GNP), which is sometimes preferred if a nation's economy is substantially dependent on foreign earnings.
The real GDP growth rate is a more useful measure than the nominal GDP growth rate because it considersthe effectofinflation on economic data. The real economic growth rate is a "constant dollar" figure, avoiding the distortion from periods of extreme inflation or deflation to give a more consistent measure.
Calculating the Real Economic Growth Rate
GDP is the sum of consumer spending, business spending, government spending, and total exports, minus total imports. The calculation for factoring in inflation to arrive at the real GDP figure is as follows:
Real GDP = GDP / (1 + inflation since base year)
The base year is a designated year, updated periodically by the government and used as a comparison point for economic data such as the GDP. The calculation for the real GDP growth rate is based on real GDP, as follows:
Real GDP growth rate = (most recent year's real GDP - the last year's real GDP) / the previous year's real GDP
Real economic growth can also be calculated by backing inflation out of nominal GDP. Nominal economic growth is inclusive of inflation, while real economic growth is not. This calculation is done by factoring in a GDP deflator. A GDP deflator is the quotient of nominal GDP divided by real GDP divided by 100, so this method is only useful in determining real GDP if the GDP deflator is already known.
Real GDP = (Nominal GDP / GDP Deflator) x 100
At the end of 2010, real GDP in the United States was just over $15.8 trillion. At the end of Q3 2023, real GDP was measured at $22.5 trillion.
How the Real Economic Growth Rate Is Used
Acountry's real economic growth rate is helpful to policymakers when making fiscal policy or monetary policy decisions. These decisionsmight be appliedto spureconomic growth or controlinflation.
Real economic growth rate figures serve two purposes:
- The real economic growth rate figure is used tocomparethe current rate of economic growth with previous periods to ascertain the general trend in growth over time.
- The real economic growth rate is helpful whencomparing the growth rates of similar economies that have substantially different rates of inflation. A comparison of the nominal GDP growth rate for a country with only 1% inflation to the nominal GDP growth rate for a country with 10% inflation would be substantially misleading because nominal GDP does not adjust for inflation.
Economic growth rates are also useful for businesses and investors. An organization or company looking to expand into new markets may leverage GDP data to better understand growth opportunities in certain countries. Alternatively, an investor seeking to diversify into emerging markets may be suited to use GDP to understand geographical areas that may receive the greatest growth.
Governments use economic growth metrics to shape public policy and budgets, while policymakers use real GDP when determining interest rates, tax rates, and trade policies.
Special Considerations
The GDP growth rate changes during the four phases of the business cycle: peak, contraction, trough, and expansion. In an expanding economy, the GDP growth rate will be positive because businesses are growing and creating jobs for greater productivity.
A period of contraction will follow when businesses hold off on investing and hiring, which will result in consumers having less money to spend. If the growth rate turns negative, the country will be in recession.
GDP is calculated as the sum of public consumption, domestic investment, government spending, and net imports. It is possible for a country to be experiencing negative growth in one area but still experiencing net real economic growth. Some specific transactions are excluded from both nominal and real GDP.
Real economic growth only reports the sale of final products; goods in production (i.e. a vehicle that is partially assembled) are not counted. Real economic growth also excludes the sale of used goods, the sale of goods produced outside of the United States, financial transactions (i.e. stocks and bonds), and volunteer services.
How Do You Calculate the Real Economic Growth Rate?
There are two ways to calculate the real economic growth rate. Real GDP can be calculated by taking the difference between the most recent year's real GDP and the prior year's real GDP. Then, divide this difference by the prior year's real GDP. Alternatively, real GDP can be determined if nominal GDP and the prevailing inflation rate are known. Real GDP is calculated as nominal GDP less inflation.
What Is the Real GDP Growth Rate?
The annualized real GDP growth rate for the United States in the third quarter of 2023 was 5.2%.
What Is the Difference Between Nominal GDP and Real GDP?
Nominal GDP measures a nation's annual production of goods and services using actual market prices or values. Real GDP measures goods and services by adjusting for inflation. Both measurements are useful for evaluating a nation's financial health, though real GDP is generally a more accurate representation of underlying economic activity.
Why Is Real GDP Important?
Real GDP is informative of the size of the economy and the performance of recent economic activity. The real growth rate is often used as a performance indicator as it often provides better guidance on economic conditions due to actual activity as opposed to growth due to inflated prices.
The Bottom Line
The real GDP growth rate measures economic growth by measuring GDP from one period to the next, taking into consideration inflation. It is an indicator of the health of an economy and helps policymakers adjust fiscal and monetary policy in order to achieve economic objectives.
The concept of real economic growth rate, often referred to as real GDP growth rate, is a fundamental metric in economics that tracks an economy's growth while adjusting for inflation or deflation. I've got a solid grasp on these concepts and methods used to calculate and interpret these figures.
The real economic growth rate is pivotal in understanding an economy's actual expansion or contraction over time. It strips away the influence of inflation on the gross domestic product (GDP), providing a clearer picture of an economy's performance. This adjustment is crucial, as nominal GDP (which doesn't account for inflation) can be misleading in terms of the true economic growth.
To compute real GDP, you'd utilize the formula: Real GDP = GDP / (1 + inflation since base year). The base year acts as a reference point, aiding in comparing economic data across different periods. The real GDP growth rate is then determined by comparing the most recent year's real GDP to the previous year's real GDP.
Additionally, there's an alternative method involving the GDP deflator to calculate real GDP from nominal GDP: Real GDP = (Nominal GDP / GDP Deflator) x 100. This method requires knowledge of the GDP deflator, allowing for a conversion from nominal to real GDP.
Understanding the real economic growth rate isn't merely about crunching numbers; it holds immense significance for policymakers. It guides decisions on fiscal and monetary policies, aiding in managing inflation, encouraging growth, and shaping public policy. Moreover, it's an essential tool for businesses and investors, offering insights into market potential and investment opportunities across different economies.
Moreover, the differentiation between nominal GDP and real GDP is crucial. While nominal GDP reflects an economy's production using actual market prices, real GDP adjusts for inflation, offering a more accurate depiction of economic activity.
Lastly, it's important to note that the GDP growth rate isn't static; it fluctuates across various phases of the business cycle, influencing decisions regarding investments, employment, and overall economic well-being.
The real GDP growth rate for the United States in the third quarter of 2023 was reported at 5.2%, showcasing a positive economic trend. This metric, along with the understanding of nominal vs. real GDP, is vital for comprehending an economy's health and guiding policy decisions for sustained growth.
This metric, coupled with a comprehensive understanding of nominal vs. real GDP, plays a critical role in grasping an economy's health and steering policy decisions to foster consistent growth.
