Economists use real gross domestic product (GDP) when they want to monitor the growth of output in an economy. Nominal GDP, typically referred to as just GDP, uses the quantities and prices in a given time period to track the total value produced in an economy over a certain time. Conversely, real GDP tracks the total value produced using constant prices, isolating the effect of price changes. As a result, real GDP is an accurate gauge of changes in the output level of an economy.

The Bureau for Economic Analysis (BEA) calculates real GDP by removing the effects of inflation from GDP using a GDP price deflator. The deflator is the difference in prices between the current year and base year chosen by the BEA for comparison. For example, if prices rose by 5% since the base year, the deflator would be 1.05. Nominal GDP is divided by this deflator, yielding real GDP.

Output growth is a key estimate for policymakers. For example, the Federal Reserve factors GDP into its decisions on influencing the money supply, and these decisions affect the entire economy. If GDP growth is low or negative, the Federal Reserve funds rate is decreased, making it more difficult for banks to acquire capital. As a result, banks can make fewer loans to individuals and businesses, which slows down economic growth. This is an appropriate policy response when the economy is in a downturn, but nominal GDP cannot convey that information. Negative growth of nominal GDP may be due to a decrease in prices or a decrease in output, but negative growth of real GDP can only be due to a decrease in output. (For more, see: Nominal vs. Real GDP.)

  1. Is real GDP a better index of economic performance than GDP?

    Learn why real GDP is a better index for expressing the output of an economy, as it takes into account the factors that distort ... Read Answer >>
  2. How much of an economy's performance is captured by real GPD?

    Learn about the economic information captured by real GDP. Find out how real and nominal GDP are constructed and the purposes ... Read Answer >>
  3. What is GDP and Why Is It So Important To Investors?

    The gross domestic product (GDP) is one the primary indicators used to gauge the health of a country's economy. What does ... Read Answer >>
  4. What are some alternatives to real GDP?

    Learn about economic measures used instead of real GDP and the limitations of real GDP. Find out in which situations nominal ... Read Answer >>
  5. How does the United States government measure economic growth?

    Find out how the Bureau of Labor Statistics and the Bureau of Economic Analysis measure economic growth in the United States ... Read Answer >>
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  1. Gross Domestic Product - GDP

    GDP is the monetary value of all the finished goods and services ...
  2. GDP Price Deflator

    An economic metric that accounts for inflation by converting ...
  3. Nominal GDP

    A gross domestic product (GDP) figure that has not been adjusted ...
  4. Real Economic Growth Rate

    A measure of economic growth from one period to another expressed ...
  5. Inflationary Gap

    An inflationary gap is a macroeconomic condition describing the ...
  6. Nominal

    An unadjusted rate, value or change in value. This type of measure ...
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