What is the 'Real Economic Growth Rate'?

The real economic growth rate measures economic growth in relation to gross domestic product (GDP) from one period to another and adjusted for inflation. Alternatively, it is 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 gross national product (GNP), which is sometimes preferred if a nation's economy is substantially dependent on foreign earnings.

BREAKING DOWN 'Real Economic Growth Rate'

The real economic growth rate, also referred to as the growth rate of real GDP, 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, provides a consistent measure that is not distorted by periods of extreme inflation or deflation.

Calculating the Real GDP Growth Rate

GDP is calculated as the sum of consumer spending, business spending, government spending and total exports minus total imports. To factor in inflation and arrive at the real GDP figure, the calculation is as follows:

Real GDP = GDP / (1 + Inflation since base year)

The base year is a designated year, updated periodically by the government, that is used as a comparison point for economic data such as the GDP.

Once real GDP is calculated, the real GDP growth rate is calculated as follows:

Real GDP growth rate = (most recent year's real GDP - the previous year's real GDP) / the previous year's real GDP

Using the Real Economic 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 are commonly used for 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 of the rate of 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 is not adjusted for inflation.

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