Real Economic Growth Rate Definition

What is the real economic growth rate?

The real economic growth rate, or real GDP growth rate, measures economic growthas expressed by Gross Domestic Product (GDP), period over period, adjusted for inflation or deflation. In other words, it reveals changes in the value of all goods and services produced by an economy – a country’s economic output – while taking price fluctuations into account.

Understanding the Real Economic Growth Rate

The real economic growth rate is expressed as a percentage which shows the rate of change in a country’s GDP, usually from year to year. Another measure of economic growth is the gross national product (GNP)which is sometimes preferred if a country’s economy is largely dependent on foreign income.

The real GDP growth rate is a more useful measure than the nominal GDP growth rate because it takes into account the effect inflation on economic data. The real economic growth rate is a “constant dollar” figure, avoiding the distortion due to periods of extreme inflation or deflation to give a more consistent measurement.

Calculation of the real economic growth rate

GDP is the sum of consumer spending, business spending, government spending, and total exportsminus the total imports. The calculation to take inflation into account 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, periodically updated by the government and used as a benchmark for economic data such as GDP. The calculation of the real GDP growth rate is based on real GDP, as follows:

Real GDP growth rate = (Real GDP of the most recent year – Real GDP of the previous year) / Real GDP of the previous year

Real economic growth can also be calculated by removing inflation from nominal GDP. Nominal economic growth includes inflation, while real economic growth does not. This calculation is made by integrating a GDP deflator. A GDP deflator is the quotient of nominal GDP divided by real GDP divided by 100, so this method is only useful for determining real GDP if the GDP deflator is already known.

Real GDP = (Nominal GDP / GDP deflator) *100

Use of real economic growth rate

A country’s real economic growth rate is useful to government policy makers when tax policy the decisions. These decisions could be applied to stimulate economic growth or control inflation.

The real economic growth rate figures serve two purposes:

1. The real economic growth rate figure is used to compare the current economic growth rate with previous periods to determine the general trend of growth over time.
2. The real economic growth rate is useful for comparing the growth rates of similar economies that have significantly different inflation rates. A comparison of the nominal GDP growth rate of a country with only 1% inflation to the nominal GDP growth rate of a country with 10% inflation would be significantly misleading because nominal GDP does not adjust to inflation.

Economic growth rates are also useful for businesses and investors. An organization or business looking to expand into new markets can leverage GDP data to better understand growth opportunities in certain countries. Alternatively, an investor seeking to diversify into emerging markets may be able to use GDP to understand which geographies are likely to receive the greatest growth.

Special Considerations

The GDP growth rate evolves during the four phases of the business cycle: peak, contraction, trough and expansion. In an expanding economy, the GDP growth rate will be positive as businesses expand and create jobs for greater productivity.

However, if the growth rate exceeds 3% or 4%, economic growth may stagnate. A period of contraction will ensue as businesses hesitate to invest and hire, as this will result in consumers having less money to spend. If the growth rate becomes negative, the country will be in recession.

GDP is calculated as the sum of government consumption, domestic investment, government expenditure and net imports. It is possible for a country to experience negative growth in one area while continuing to experience net real economic growth. Some specific transactions are excluded from both nominal and real GDP.

Real economic growth only brings in the sale of finished products; goods in production (ie a partially assembled vehicle) are not counted. Real economic growth also excludes the sale of used goods, the sale of goods produced outside the United States, financial transactions (i.e. stocks and bonds), and volunteer services.