Real Economic Growth Rate: Definition, Calculation, and Uses

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.

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

Real economic growth can also be calculated by backing inflation out of nominal GDP. Nominal economic growth is inclusive of inflation, while real economic growth is not. This calculation is done by factoring in 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 in determining real GDP if the GDP deflator is already known.

Real GDP = (Nominal GDP / GDP Deflator) x 100

How the Real Economic Growth Rate Is Used

A country's real economic growth rate is helpful to policymakers when making fiscal policy or monetary policy decisions. These decisions might be applied to spur economic growth or control inflation.

Real economic growth rate figures serve two purposes:

1. 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.
2. 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.

Economic growth rates are also useful for businesses and investors. An organization or company looking to expand into new markets may leverage GDP data to better understand growth opportunities in certain countries. Alternatively, an investor seeking to diversify into emerging markets may be suited to use GDP to understand geographical areas that may receive the greatest growth.

Special Considerations

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.

A period of contraction will follow when businesses hold off on investing and hiring, which will result in consumers having less money to spend. If the growth rate turns negative, the country will be in recession.

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

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

The Bottom Line

The real GDP growth rate measures economic growth by measuring GDP from one period to the next, taking into consideration inflation. It is an indicator of the health of an economy and helps policymakers adjust fiscal and monetary policy in order to achieve economic objectives.