What is the “GDP level” and why is it discussed in news reports, government meetings, and investment reports? Essentially, it answers a simple question: how large is our economy right now.
The rate of change in GDP is the main tool for assessing a country’s economy. GDP can be expressed either in the country’s national currency or, for comparison purposes, in US dollars.
Why is the GDP level important? It provides a “scale” for all other indicators: shares of government spending and tax revenues, debt burden, investment activity, and foreign trade. Businesses use it to assess market size and plan sales; governments use it to calibrate budgets and monetary policy; investors use it to understand where we are in the economic cycle. However, GDP is not a happiness meter: it poorly captures income distribution, environmental quality, and informal employment, so it should always be considered alongside other metrics.
What does “Gross” and “Domestic” mean?
“Gross” means that GDP measures all production, regardless of its purpose. Production can be aimed at immediate consumption, investment in new fixed assets, or replacement of depreciated fixed assets.
“Domestic” means that GDP measures production within the territory of one country.
Types of GDP
There are several types of GDP:
- Nominal GDP. Nominal GDP is calculated at current prices and does not include inflation.
- Real GDP. This is nominal GDP adjusted for inflation. It is used to assess real economic growth.
- GDP per capita at purchasing power parity. GDP per capita at purchasing power parity (PPP) (simplified) = the value of all goods and services produced by a country’s residents, expressed in US dollars / total number of residents. GDP at PPP better reflects the state of affairs in a country than nominal GDP.
What makes up GDP
A country’s GDP structure consists of goods and services (both tangible and intangible) produced domestically over a year for final consumption. This includes the total value of manufactured cars or machinery, baked bread, rolls, and pastries, as well as the value of lectures delivered at universities and patients treated at clinics.
How is GDP calculated?
There are many ways to measure GDP. Today, two main calculation principles are used:
- Income approach – summing up the value of produced goods and services;
- Expenditure approach – summing up the funds spent over the year.
When calculated correctly, both sums should be approximately equal.
Why is the GDP level important for Forex traders?
Currency analysts do not focus on the absolute value of GDP, but rather on its rate of change, expressed as a percentage compared to the previous quarter or year. Growth indicates economic stability and, as a result, suggests a rise in the national currency’s exchange rate. Conversely, a decline in GDP signals economic problems and leads to a fall in the national currency’s exchange rate. Additionally, GDP growth or weakness changes expectations regarding central bank policy, affects bond yields, and, consequently, impacts the currency rate.
Related articles
- What is the IMF?
- What is inflation?
- What is the WTO?
