Real GDP vs. Nominal GDP: An Overview
Real gross domestic product (GDP) is a more accurate reflection of the output of an economy than nominal GDP. By eliminating the distortion caused by inflation or deflation or by fluctuations in currency rates, real GDP gives economists a clearer idea of how the total national output of a country is growing or contracting from year to year.
- A nation's GDP is the total value of all of its consumer and government spending, investments, and exports, minus the value of its imports.
- Nominal GDP reflects the raw numbers in current dollars unadjusted for inflation.
- Real GDP adjusts the numbers by fixing the currency value, thus eliminating any distortion caused by inflation or deflation.
Nominal vs. Real GDP
Gross domestic product is the total value of all of the goods and services produced by a nation in a given period, usually monthly, quarterly, and yearly. The raw numbers include all consumer spending, government spending, investments, and exports. Total imports are deducted.
When this number is tracked from year to year, it is seen as an important indicator of the economic health of the nation.
Real GDP adjusts the number in order to discount the effects of inflation or deflation, and currency fluctuations up or down. To accomplish this, a fixed unit of currency is used.
U.S. GDP Over a Decade
For example, the St. Louis Fed charts the Real GDP of the U.S. in "chained" 2012 dollars, meaning that the value of the dollar in 2012 is used for subsequent years. Its chart shows the economy growing fairly steadily from about $15.7 trillion in 2011 to about $19 trillion through 2019, then falling off a cliff at the start of 2020 due to the global COVID-19 pandemic. It then starts to recover.
A more dramatic example can be seen in this Statista chart of U.S. Real GDP for the same period. However, Statista notes that the methodology of adjusting the numbers makes the 2021 decline in GDP look more extreme than it actually was. The numbers for each quarter are annualized, meaning that they are adjusted to indicate what the number would be if it occurred over an entire year.
Nominal GDP is also called "current dollar" GDP. It is the total in dollars (or any other currency) of goods and services consumed, plus government expenditures, investments, and exports, minus total imports.
The effects of inflation or deflation, and the fluctuations of currency, can convey a false picture of whether and how much an economy is growing or contracting over any given period of time.
Nominal GDP is used when comparing GDP to any other economic indicator that is not adjusted for inflation.
When Nominal GDP Is Used
Nominal GDP has its uses. It is always used when GDP is being compared to any other factor that is not inflation-adjusted. For example, a comparison of a nation's debt to its GDP will use nominal GDP, because debt is always measured in current dollars.
As this example of nominal GDP for the U.S. from Statista shows, nominal GDP won't look much different from real GDP to the casual eye unless some seismic inflation event occurs.
Example of Real GDP vs. Nominal GDP
The reason why real GDP is a superior method of expressing national economic performance can be easily illustrated.
Consider, for example, a hypothetical country that in the year 2000 had a nominal GDP of $100 billion, while by 2010 its nominal GDP was measured at $150 billion. Over the same period of time, inflation reduced the relative value of the local currency by 50%.
Looking only at nominal GDP, the economy appears to have grown by 50% over the 10 years. But the real GDP expressed in 2000 dollars would be $75 billion, a substantial decline.
What Figures Go Into GDP?
GDP measures the economic output of a county in a given year. It can be calculated by adding up all spending by consumers, businesses, and the government. It can alternatively be arrived at by adding up all of the income received by all the participants in the economy. In theory, either approach should yield the same result.
How Do Nominal and Real GDP Values Differ?
In periods of positive inflation, real GDP will always be less than nominal GDP. The opposite would occur if there were deflation (negative inflation).
Why Do Economists Favor Real GDP?
Real GDP is often favored over nominal GDP as it accounts for the effects of inflation. Thus, if nominal GDP grew at 4% in a given year, but the inflation rate was 5%, it actually shrunk by 1% in real (constant-dollar) terms.
How Do You Compute Real GDP from Nominal GDP?
To arrive at real GDP, take the nominal GDP and divide it by the inflation rate, as measured by the GDP deflator. The U.S. Bureau of Economic Analysis (BEA) publishes the GDP deflator on a quarterly basis, currently using a base year of 2017 dollars.