Definition: Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2015 prices, expressed in U.S. dollars. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources.
What is real economic growth and why are we interested in it?
Countries use the real GDP growth rate to measure economic growth because it serves as a barometer to assess their size and the performance of their economic activities. It is sometimes regarded as a performance indicator because it depicts the type of economic conditions of a nation due to actual economic activity as against growth influenced by inflated prices of goods and services. The real GDP growth rate reveals the extent of the increase or decrease in overall economic activity adjusted for inflation based on the level of goods and services produced between two consecutive years.
Technically, to compute real GDP growth, we first compute real GDP using the prices of a “base year”:
Nominal GDP in year t = Output of product A in year t * Price of product A in year t + Output of product B in year t * Price of product B in year t + … other products
Real GDP in year t = Output of product A in year t * Price of product A in base year + Output of product B in year t * Price of product B in base year + … other products
Nominal GDP growth is the percent change of the nominal GDP from one year to the next. Real growth is the percent change in the real GDP. Since the real GDP for all years is calculated using the same prices from the base year, comparing the real GDP from one year to the next tells us how the actual production volumes changed. To make that comparison, we keep prices constant. Otherwise, if we compare nominal GDP between two years, we don’t know how much of the change is due to production changes and how much is due to price changes.
Long-run growth is the average rate of change in real GDP over many years. We care about the long-run growth rate as it has a compounding effect. The increase of GDP in one year builds on the increase in the GDP during the previous year and so forth. Therefore, a sustained high rate of economic growth can have a profound impact on the income levels in a country. For those interested in the mechanics of long-term growth, you can read the seminal paper on economic growth
by Robert Solow.
Business cycles are the oscillations of economic growth around its long-term level. As an indicative parameter of aggregate economic wellbeing, movement in the rate of change in the real GDP explains the cyclicality in the economic transactions among productive agents in a specific country. For instance, positive values of the real GDP growth rate show that the country is experiencing an expansion in economic activity. However, if the indicator is negative, it means that there is a reduction in the level of aggregate output in the country. Economists use the real GDP growth rate to evaluate the business cycle phase of countries. Situations such as peaks and troughs along the business cycle trajectories also indicate the changes in real GDP growth over time. The peaks depict the pinnacle of the business cycle while its counterpart, troughs, refers to the depressive status of a country following a consequent decline in real GDP growth over time. Moreover, the movement from peak to trough shows that there is a recession, whereas the transition from the latter to the former reveals the stage of economic recovery.
How exactly do we mark the points of the business cycle? You can look at the dating procedure
of the National Bureau of Economic Research in the U.S.
Economists and policymakers address fluctuations in economic growth through several policy instruments grouped broadly into automatic stabilizers and discretionary tools. The automatic stabilizers correspond to economic policies used by the government without additional actions by policymakers. These include the implementation of expansionary policies when the economy slows down and the introduction of contractionary instruments during an economic boom. Meanwhile, discretionary policies are instruments utilized by policymakers to augment the automatic stabilizers when they fail to promote the desired goal of the macroeconomy. These address changes to government fiscal spending and taxation as well as monetary policies.