Why Not Consider Inflation When Measuring the GDP?

by Wilhelm Schnotz

Economists use a measure known as a nation's gross domestic product, or GDP, to represent the amounts spent on goods and services, invested and spent by the government, and the value of net exports. The GDP is often used as broad indicator of a country's economic health from year to year. Economists measure the GDP in two ways: nominal GDP, which ignores inflation and other factors; and real GDP, which indexes prices against standard dollars adjusted for inflation.

Nominal GDP

Nominal GDP measures the amount spent on goods and investment in a nation's economy for a year, using the value for those goods using that year's prices. Nominal GDP is simply a snapshot on the amount of money spent in a nation's economy. Its unadjusted figures are raw data, and they aren't influenced by inflationary pressures So nominal GDP provides a clear picture of how much wealth traded hands in the course of a year, and it also can be used to craft nominal, or unadjusted, GDP per person, a measure of a country's relative standard of living.

Real GDP

Because prices of all goods tend to creep higher as time passes, a process known as inflation, economists traditionally account for inflation when comparing GDPs between years. This measure, known as real GDP, adjusts the nominal GDP measurement of raw economic data to fit against a single year's prices. Economists take prices from the original year, known as the base year, and apply them to quantities of goods sold and investments made in the current year. This method provides a GDP measurement that ignores inflation, allowing economists to accurately compare a nation's economic growth over two periods.

Differences in Results

When economists don't consider inflation when comparing GDP between two years, the results can be misleading. If only considering raw data are used, comparing the nominal GDP of two consecutive years could indicate that a country's economy grew by 12 percent. But this figure might be misleading: If the inflation rate was 7 percent, the nation's economy grew only 5 percent. Because real GDP factors inflation into its figures, economic growth rates are more accurate when calculated using real GDP figures.

GDP Deflator

Although nominal GDP statistics don't accurately provide comparative indexes, economists use nominal measurements when calculating the GDP deflator, a figure that represents the rate of change in prices. Economists calculate the GDP deflator by dividing the nominal GDP by the real GDP and multiplying the result by 100. This deflator number indexes the change in value of the same goods over the same year, and it is a way to measure inflation rates between years.

About the Author

Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.

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