What Is the Real Economic Growth Rate?

What Is the Real Economic Growth Rate?

Let me explain to you what the real economic growth rate is. It's the measure of economic growth shown through gross domestic product (GDP), but adjusted for inflation or deflation. Essentially, it shows you the changes in the value of all goods and services an economy produces— that's the country's economic output—while factoring in price changes.

Understanding the Real Economic Growth Rate

The real economic growth rate comes as a percentage, showing you the rate of change in a country's GDP, usually from one year to the next. There's also gross national product (GNP), which some prefer if an economy relies heavily on foreign earnings.

I find the real GDP growth rate more useful than the nominal one because it accounts for inflation's impact on the data. It's a 'constant dollar' figure, which avoids distortions from extreme inflation or deflation periods, giving you a more consistent measure.

Calculating the Real Economic Growth Rate

GDP is the total of consumer spending, business spending, government spending, and exports minus imports. To get the real GDP figure by factoring in inflation, use this: Real GDP = GDP ÷ (1 + inflation since base year). The base year is a specific year the government updates periodically as a benchmark for economic data like GDP.

For the real GDP growth rate, calculate it like this: Real GDP growth rate = (most recent year's real GDP - the last year's real GDP) ÷ the previous year's real GDP.

You can also figure real economic growth by removing inflation from nominal GDP. Nominal growth includes inflation, but real growth doesn't. This involves a GDP deflator, which is nominal GDP divided by real GDP, then divided by 100. So, if you know the deflator, real GDP = (Nominal GDP ÷ GDP Deflator) x 100.

Fast Fact

At the end of 2010, real GDP in the United States was $17 trillion. By the end of Q3 2024, it measured $23.4 trillion.

How the Real Economic Growth Rate Is Used

A country's real economic growth rate helps policymakers with fiscal or monetary policy decisions, like spurring growth or controlling inflation.

This rate serves two main purposes: First, it lets you compare the current growth rate with past periods to spot the overall trend. Second, it's useful for comparing growth in similar economies with very different inflation rates—comparing nominal rates would mislead you because they don't adjust for inflation.

Businesses and investors find economic growth rates valuable too. If you're a company expanding into new markets, you might use GDP data to assess growth opportunities in different countries. As an investor diversifying into emerging markets, GDP can show you areas with the most potential growth.

Important

Governments rely on economic growth metrics to form public policy and budgets, while policymakers use real GDP to set interest rates, tax rates, and trade policies.

Special Considerations

The GDP growth rate shifts through the business cycle's four phases: peak, contraction, trough, and expansion. In expansion, growth is positive as businesses grow and create jobs for more productivity.

Contraction follows when businesses cut back on investing and hiring, leaving consumers with less to spend. If growth goes negative, you're in a recession.

GDP sums public consumption, domestic investment, government spending, and net imports. A country might have negative growth in one area but still net positive real economic growth. Certain transactions are left out of both nominal and real GDP.

Real economic growth only counts final product sales; it skips goods in production, like a partially assembled vehicle. It also excludes used goods sales, goods produced abroad, financial transactions like stocks and bonds, and volunteer services.

How Do You Calculate the Real Economic Growth Rate?

There are two methods to calculate it. Take the difference between the most recent year's real GDP and the prior year's, then divide by the prior year's real GDP. Or, if you know nominal GDP and the inflation rate, calculate real GDP as nominal GDP minus inflation.

What Is the Real GDP Growth Rate?

For the United States in the third quarter of 2024, the annualized real GDP growth rate was 3.1%.

What Is the Difference Between Nominal GDP and Real GDP?

Nominal GDP measures a nation's yearly production using actual market prices. Real GDP adjusts for inflation. Both help evaluate financial health, but real GDP gives a more accurate picture of underlying activity.

Why Is Real GDP Important?

Real GDP tells you about the economy's size and recent performance. The real growth rate is a strong performance indicator because it focuses on actual activity, not just inflated prices.

The Bottom Line

The real GDP growth rate measures economic growth by comparing GDP from one period to the next, accounting for inflation. It's a key indicator of economic health and guides policymakers in adjusting fiscal and monetary policies to meet objectives.