What is real GDP?
Real GDP is a measure of a country’s gross domestic product that has been adjusted for inflation. Contrast this with nominal GDP, which measures GDP using current prices, without adjusting for 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 most important way to take a country’s economic temperature. It totals the monetary value of all goods and services produced in a given time period, less the value of the goods and services used up in production. Both corporations and small businesses rely on GDP to plan for the future. Investors use it to help estimate profit margins and make financial decisions. Economists use it to aid forecasting and gain insight into the economy.
The regular pulse of prices rising and falling (mostly rising) is captured by nominal GDP, which tracks growth in value of an economy over time. If overall gross domestic product rises 3 percent in a year and inflation runs at 2 percent over the same period, nominal GDP will be +5 percent for that year.
When comparing GDP to other economic data that are not adjusted for inflation, nominal GDP is the preferred figure. For instance, debt is always presented as a nominal amount, so debt-to-GDP ratios are calculated using nominal GDP data. Keep in mind that nominal GDP can provide an inaccurate picture of economic growth exactly because inflation is baked into the data.
Real GDP provides a more precise picture of a nation’s rate of economic growth. The GDP deflator is utilized to adjust the data for inflation, allowing you to understand how much economic output has grown (or contracted) independent of price changes.
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.
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Real GDP example
In the first quarter of 2016, U.S. real GDP increased by 1.1 percent, while nominal GDP grew by 1.4 percent. The core PCE inflation index — the measure of inflation used to adjust for real GDP — increased 1.4 percent. This figure, used in the GDP deflator calculation, accounts for the difference between real and nominal GDP in the quarter