What Is the Real Economic Growth Rate?
The real economic growth, or real GDP growth rate, measures economic growth as it relates to the gross domestic product (GDP) from one period to another, adjusted for inflation, and expressed in real terms as opposed to nominal terms. The real economic growth rate is expressed as a percentage that shows the rate of change in a country's GDP, typically, from one year to the next. Another economic 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 economic growth rate considers inflation in its measurement of economic growth, unlike the nominal GDP growth rate.
- The real economic growth rate avoids the distortion caused by periods of extreme inflation or deflation.
- The real economic growth rate is used by policymakers to determine growth over time and to compare the growth rates of similar economies with different rates of inflation.
Why Use the Real GDP Growth Rate?
The real GDP growth rate is a more useful measure than the nominal GDP growth rate because it considers the effect of inflation on economic data. The real economic growth rate is a "constant dollar" figure and, therefore, avoids the distortion from periods of extreme inflation or deflation and is a more consistent measure.
Calculating the Real GDP Growth Rate
The gross domestic product 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
Using the Real GDP Growth Rate
A country's real economic growth rate is helpful to government policymakers when making fiscal policy decisions. These decisions might be applied to spur economic growth or control inflation. Real economic growth rate figures serve two purposes. First, the real economic growth rate figure is used to compare the current rate of economic growth with previous periods to ascertain the general trend in growth over time. Second, the real economic growth rate is helpful when comparing 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.
Real World Example
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. However, if the growth rate exceeds 3 or 4%, economic growth may stall. A period of contraction will follow when businesses will hold off on investing and hiring, which means consumers have less money to spend. If the growth rate turns negative, the country will be in recession.
Contraction happened most recently in late 2008 and early 2009 when U.S. GDP growth was negative for four quarters in a row. Contraction had not occurred since the Great Depression. After the financial crisis of 2008 and 2009, the U.S. economy rebounded. According to Karim Foda and Eswar Prasad, expert economists writing for the Brookings Institution in 2018, the U.S. shows real GDP growth that is 18% higher than it was before the financial crisis. However, when measured on a per capita or per working-age person basis, the real GDP growth in the United States is less impressive than that of Germany and Japan.