What Is the GDP Growth Rate?
Why It's Important, How to Calculate It
The GDP growth rate measures how fast the economy is growing. It does this by comparing one quarter of the country's gross domestic product to the previous quarter. GDP measures the economic output of a nation.
The GDP growth rate is driven by the four components of GDP. The main driver of GDP growth is personal consumption. This includes the critical sector of retail sales. The second component is business investment, including construction and inventory levels.
Government spending is the third driver of growth. Its largest categories are Social Security benefits, defense spending and Medicare benefits. The government often increases spending to jumpstart the economy during a recession. Fourth is net trade. Exports add to GDP while imports subtract from it.
Why It's Important
The GDP growth rate is the most important indicator of economic health. It changes during the four phases of the business cycle: expansion, peak, contraction and trough.
When the economy is expanding, the GDP growth rate is positive. If it's growing, so will businesses, jobs and personal income. But if it expands beyond 3-4 percent, then it could hit the peak. At that point, the bubble bursts and economic growth stalls.
If it's contracting, then businesses will hold off investing in new purchases. They’ll delay hiring new employees until they are confident the economy will improve.
Those delays further depress the economy. Without jobs, consumers have less money to spend.
If the GDP growth rate turns negative, then the country's economy is in a recession. With negative growth, GDP is less than the quarter or year before. It will continue to be negative until it hits a trough. That’s the month things start to turn around.
After the trough, GDP turns positive again.
Contraction happened most recently in late 2008 and early 2009. U.S. GDP growth was negative for four quarters in a row. The last time this happened was during the Great Depression. The growth rate turned positive in Q2 2008. It then turned negative again, prompting concerns about a double-dip recession. In the 2001 recession, the growth rate had been negative for only two quarters. To see all occurrences of negative economic growth, see History of Recessions.
The Bureau of Economic Analysis uses real GDP to measure the U.S. GDP growth rate. Real GDP takes out the effect of inflation. Even though the growth rate is reported quarterly, the BEA annualizes it. That's so it can compare growth to the previous year. In other words, in any given quarter, the BEA reports what GDP is for the year. That removes the effect of seasons. If the BEA didn't do this, you would see a huge jump in GDP and the growth rate in every fourth quarter. That's because the holiday shopping season accounts for the greatest portion of annual personal consumption.
The BEA often revises the GDP growth rate within a month after releasing it. That’s because it measures so many variables.
It will update its estimates as new data comes in. Those revisions impact the stock market as investors get this new information about the state of the economy's health. To see how much the BEA has revised its estimates, see GDP Current Statistics.
The BEA provides a formula for calculating the U.S. GDP growth rate. Here's a step-by-step example for the Fourth Quarter 2017:
- Go to Table 1.1.6, Real Gross Domestic Product, Chained Dollars, at the BEA website.
- Divide the annualized rate for Q4 2017 ($17.2725 trillion) by the Q3 2017 annualized rate ($17.1639 trillion). You should get 1.0063.
- Raise this to the power of 4. (There's a function called POWER that does that in Excel.) You should get 1.0256.
- Subtract one. You should get 0.0256.
- Convert to a percentage by multiplying by 100. You should get 2.555, or 2.6 percent when it's rounded to one decimal place.
That is the same as the BEA's final estimate for GDP growth for that quarter. (Source: “Why Does the BEA Present Quarterly Series at an Annual Rate?” BEA.)