Real GDP and How to Calculate It Compared to Nominal

What Makes Real GDP So Incredibly Real?

real gdp
••• Real GDP takes out the impact of rising prices. Photo by Justin Sullivan/Getty Images

Real GDP is a measurement of economic output that accounts for the effects of inflation or deflation. It reports the gross domestic product as if prices never went up or down, which gives a more realistic assessment of growth. Otherwise, it could seem like a country is producing more when it's only that prices have gone up. 

Real Versus Nominal GDP

When you hear reports of a country’s GDP that don’t specify the type of GDP, it is likely nominal GDP. Nominal GDP includes both prices and growth, while real GDP is pure growth.  It’s what nominal GDP would have been if there were no price changes from the base year. As a result, nominal GDP is usually higher.

The U.S. Bureau of Economic Analysis reports both real and nominal GDP. It calculates real U.S. GDP as an annual rate from a designated base year. It excludes imports and foreign income from American companies and people. That negates the impact of exchange rates

How to Calculate Real GDP

The formula for real GDP is nominal GDP divided by the deflator:

R = N/D.

The Bureau of Economic Analysis calculates the deflator for the United States. It measures inflation since the base year. That is the ratio of what it would cost today compared to the base year. It's similar to the Consumer Price Index but is weighted differently. The BEA publishes so-called implicit price deflators in NIPA table 1.1.9, which you can find in the Interactive Tables. This is where you can find implicit price deflators for five different base years:

  1. Table 1.1.6. Real Gross Domestic Product, Chained (2009) Dollars 
  2. Table 1.1.6A. Real Gross Domestic Product, Chained (1937) Dollars
  3. Table 1.1.6B. Real Gross Domestic Product, Chained (1952) Dollars
  4. Table 1.1.6C. Real Gross Domestic Product, Chained (1972) Dollars
  5. Table 1.1.6D. Real Gross Domestic Product, Chained (1992) Dollars

How It Measures Production

Real GDP measures the final output of all goods and services produced in the United States in the prior quarter. It does not measure sales. For example, the BEA counts a new car when it's shipped to the dealer. The BEA records it as an addition to inventory, which increases GDP. When the dealer sells it, then the BEA records it as a subtraction to inventory. That reduces GDP until the factory builds another car to replace it. For more, see Components of GDP.

GDP only counts final production. The BEA does not count the parts manufactured to make the car, such as tires, steering wheel or engine. (Source: "GDP Primer," Bureau of Economic Analysis.)

How It Measures Services

Real GDP also measures services. These include your hairdresser, your bank, and even the services provided by non-profits such as Goodwill. It includes services provided by the U.S. military, even when troops are overseas. It also measures housing services provided by and for persons who own and live in their home, including maid service.

But the BEA doesn't count some services because they're too difficult to measure. These include unpaid childcare, elder care or housework, volunteer work for charities, or illegal or black-market activities. Read The Real Wealth of Nations to see why this could provide a false measurement of economic growth.

Why Real GDP Is Important

Real GDP is important for two reasons. First, it tells you how much the economy is producing. The GDP components report divides production into categories, so you can tell what contributes the most to the economy. Real GDP can be used to compare the size of economies throughout the world. But, to compensate for the different cost of living between countries, you must use purchasing power parity. Find out how to compare GDP by country.

Real GDP is also used to compute economic growth. The percentage change in real GDP is the GDP growth rate. You need to use real GDP so you can be sure you’re calculating real growth, not just price and wage increases. Here's how to calculate the GDP growth rate.

Real GDP can then be used to determine if the U.S. economy is growing more quickly or more slowly than the quarter before, or the same quarter the year before. In this way, you can tell where the economy is in the business cycle. Here's the real U.S. GDP growth rate for every year since 1929.

The ideal GDP growth rate is between 2 percent and 3 percent. The BEA revises its quarterly estimate each month when it receives new data. You can see how the growth rate changed during the financial crisis in GDP Current Statistics.

The GDP growth rate is critical for investors to adjust the asset allocation in their portfolios. They also compare countries' GDP growth rates. Countries with strong growth attract more investors for their corporate stocks, bonds, and even their sovereign debt.

The Federal Reserve reviews GDP growth when deciding on the fed funds rate. It will raise the rate when growth is too fast, and lower it when growth is too slow.

When You Should Use Nominal GDP Instead

You must use nominal GDP when your other variables don't exclude for inflation. For example, if you are comparing debt to GDP, you've got to use nominal GDP since a country's debt is also nominal. Here's the U.S. debt to nominal GDP for every year since 1929.

How GDP Affects You

When the GDP growth rate is slowing down or even contracting, the Fed will lower interest rates to stimulate growth. If you are buying a home when this happens, you'd want an adjustable-rate mortgage so you can take advantage of future lower rates. You might even want to think about downsizing.

Declining GDP growth rates can also lead to a recession, which means you should prepare for layoffs. If GDP growth rates are increasing, then you'd want to consider a fixed-rate mortgage. That way, you can lock in low interest rates, because the Fed usually raises them if growth is too fast.