ETFs hold an edge because they tend to use passive investing and have some tax advantages.
What is nominal GDP?
Nominal GDP measures a country’s gross domestic product using current prices, without adjusting for inflation. Contrast this with real GDP, which measures a country’s economic output adjusted for the impact of inflation. While the two indices measure the same output, they are used for very different purposes: changes in value versus changes in volume.
GDP is the core measure of a country’s economic health, totaling the monetary value of all goods and services produced in a given time period, minus the value of the goods and services used up in production. Businesses large and small rely on GDP for major planning decisions. For investors, GDP is a guide for estimating profit margins and making financial decisions. Economists use it to understand the economy and make forecasts.
Nominal economic statistics, also called current-dollar statistics, are not adjusted to account for the price changes from inflation and deflation. The natural rise and fall (mostly rise) of prices is captured by nominal GDP, which tracks the gradual increase of the value of an economy over time. If overall gross domestic product rises 2 percent in a year and inflation runs at 2 percent over the same period, nominal GDP will be +4 percent for that year.
Nominal GDP is the preferred figure for comparing GDP to other variables that also don’t adjust for inflation. For example, debt is always calculated and expressed as a nominal figure, so debt-to-GDP ratios are always based on nominal GDP. Because inflation is baked into nominal GDP figures, it can give an inaccurate view of growth.
Economists prefer using real GDP to get a comparative picture of a nation’s rate of economic growth. Using the GDP deflator, the prices that go into calculating GDP are evened out, allowing someone to understand how much the economy has grown or contracted independent of changes in inflation.
When calculating real GDP, a base year is selected to control for inflation; the real GDP figures capture the quantities of goods produced in different years using the prices from the same base year. The different real GDP figures from various years reflect changes in volume rather than value.
Calculating nominal GDP
The nominal GDP formula relies on one of three measurement methods: income, production or expenditure. The income method adds the income earned via all of the wages, rent, interest and profits earned by businesses and households during a single year. The production method calculates net production by subtracting consumption from the estimated output in a year. Finally, the expenditure method calculates the sum of all the goods and services purchased in the country over the course of a year.
Your economic activities help determine your country’s GDP. Staying at a hotel, for example, puts money back into the economy. With a great hotel credit card, you can even get rewarded.
Nominal GDP example
In the first quarter of 2017, U.S. GDP grew by 3.4 percent on a nominal basis, but grew only 1.4 percent on a real basis, adjusted for inflation. Nominal GDP rose by $157.7 billion in the first quarter to a level of $19.03 billion. The core PCE inflation index — the measure of inflation used to adjust for real GDP — increased 2.0 percent. This figure, used in the GDP deflator calculation, accounts for the difference between real and nominal GDP in the quarter.