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—the economic output of a country—while accounting for price fluctuations.
- 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.
- It is used by policymakers to determine growth over time and 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 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 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, 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
How the Real Economic Growth Rate Is Used
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:
- 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.
- 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.
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 hold off on investing and hiring, as this will result in consumers having less money to spend. If the growth rate turns negative, the country will be in recession.