Understanding GDP Growth: Real, Nominal, and Inflation Adjustments

When discussing the economy, one of the most frequently mentioned metrics is Gross Domestic Product (GDP). GDP provides valuable insights into the health and growth of a nation's economy. However, understanding the nuances of GDP growth—whether real, nominal, or with adjustments for inflation—can be challenging. This article aims to clarify these concepts and discuss recent U.S. economic trends.

Real vs. Nominal GDP

In economic discussions, you often hear about the growth of GDP, but it can be important to distinguish between real GDP and nominal GDP.

Real GDP represents the value of goods and services produced in an economy, adjusted for inflation. It provides a more accurate measure of economic growth as it removes the effects of price changes. On the other hand, nominal GDP measures the value of goods and services produced using current prices, which includes inflation.

Recent U.S. GDP Trends

Let’s examine some recent U.S. GDP trends to better understand these differences. According to recent data, the real GDP growth for the U.S. has varied between 1.6 and 2.9 percent per year, which is slightly higher than the 1-2 percent range often cited in news reports. This range signifies the growth in the real value of production, excluding inflation.

Nominal GDP, which includes the effects of inflation, has grown at a broader range of 2.7 to 5.4 percent per year. This indicates the total value of all goods and services produced, including any price increases. It's important to note that nominal GDP growth is typically higher than real GDP growth due to the inclusion of inflation.

GDP Deflator: The Key to Adjustment

To convert nominal GDP to real GDP, economists use the GDP deflator. The GDP deflator measures the price level of all newly produced goods and services in an economy, and it allows us to compare the value of GDP across different years. It is calculated by dividing nominal GDP by real GDP and multiplying by 100. When the GDP deflator equals 100, real GDP and nominal GDP are identical.

Here’s how the GDP deflator works in practice. The table below shows nominal and real GDP for 2009-2019, along with the GDP deflator. All values are based on 2012 as the base year, where real GDP equals nominal GDP and the price deflator equals 100:

Year Nominal GDP Real GDP GDP Deflator (100 2012 base year) Nominal GDP Growth (%) Real GDP Growth (%) GDP Deflator Growth (%) 2009 13,918.87 13,910.56 101.289 2.8 0.6 1.289 2010 14,487.98 14,154.79 101.632 3.5 1.9 1.632 2011 15,076.87 14,708.91 101.969 4.1 2.1 1.969 2012 15,683.31 15,259.25 102.291 4.0 2.4 2.291 2013 16,929.54 16,353.85 102.603 8.0 2.6 2.603 2014 17,219.66 16,812.91 102.906 1.7 2.7 2.906 2015 18,022.28 17,406.20 103.202 4.5 3.0 3.202 2016 18,542.71 17,875.85 103.493 2.9 2.7 3.493 2017 19,396.32 18,659.64 103.780 4.1 2.6 3.780 2018 20,442.97 19,366.84 104.064 5.4 2.8 4.064 2019 21,427.74 19,896.64 104.298 4.8 2.7 4.298

The table shows that the GDP deflator has typically ranged between 1.0 and 2.4 percent, indicating an average annual inflation rate. This figure is crucial as it helps in understanding the true growth of the economy, as opposed to the nominal GDP growth, which is influenced by both real growth and price changes.

Growth Rate Rule of Thumb

A useful rule of thumb when working with GDP data is that the growth rate of a product of two series (like nominal GDP and the GDP deflator) is approximately equal to the sum of the growth rates of the two series taken individually. This is evident in the data:

GDP Deflator Growth Nominal GDP Growth - Real GDP Growth

For example, in 2018, the nominal GDP grew by 5.4 percent, while real GDP grew by 2.8 percent. The GDP deflator grew by 2.6 percent, which is close to the difference between the two growth rates (5.4 - 2.8 2.6).

Conclusion

To summarize, when discussing U.S. GDP growth, it's essential to differentiate between real and nominal GDP growth. Real GDP provides a more accurate measure of economic growth, while nominal GDP measures the total value of all goods and services. The GDP deflator is a key tool for adjusting nominal GDP to real GDP, allowing for a clearer understanding of inflation-adjusted growth. By considering these factors, policymakers, investors, and the general public can gain a more comprehensive view of economic performance.

Understanding these concepts can help us interpret economic data more accurately and make informed decisions based on more reliable measures of economic growth.