An increase in nominal GDP may simply indicate that prices have risen, whereas an increase in real GDP indicates that output has risen. The GDP deflator is a price index that measures the average price of goods and services generated in all sectors of a country’s economy over time.
When the GDP deflator falls, what does it mean?
We need to know the nominal and real GDPs to calculate the GDP price deflator formula. The base year in the following example is 2010. The GDP deflator is then calculated each year using the formula: Nominal GDP / Real GDP x 100 = GDP price deflator
It’s worth noting that the GDP price deflator fell in 2013 and 2014. In comparison to the base year 2010, the growth in the aggregate level of prices is smaller in 2013 and 2014. The GDP deflator measures price inflation or deflation in comparison to the base year and hence reveals the impact of inflation on the GDP.
What happens when the GDP rises?
Gross domestic product (GDP) growth that is faster boosts the economy’s overall size and strengthens fiscal conditions. Growth in per capita GDP that is widely shared raises the material standard of living of the average American.
What impact does the GDP deflator have on trade?
When the terms of trade are increasing (i.e. exhibiting a year-over-year increase), the GDP deflator has a higher rate of change than the domestic demand deflator, and vice versa when the terms of trade are degrading (i.e. showing a year-on-year decrease).
When real GDP rises, does this mean that the amount of goods and services produced has increased?
The advantage of using real GDP as a metric is that it is always increasing. When real GDP rises, it means that the amount of goods and services produced has increased. In contrast to estimated GDP, real GDP refers to a country’s actual GDP.
When the GDP deflator is negative, what happens?
For the quarter July-September 2015 (Q2 FY16), India’s GDP deflator (a measure of overall inflation) was -1.4 percent. A positive deflator value indicates that the economy is experiencing inflation, whereas a negative value, as it is now, indicates that the economy is experiencing deflation. Since 2012, the economy-wide inflation rate has been steadily declining (See chart: Uncomfortable reversal). Falling inflation is a wonderful thing, but when the GDP deflator dropped to 1.8 percent in Q1FY16, it was a little too good. If the updated GDP estimates show a negative number for the GDP deflator, India will have formally entered the deflation zone in Q2FY16.
While real GDP growth in Q2FY16 was 7.4%, the economy’s rebound may be more numerical than’real’. Let’s have a look at how this works. The GDP is initially calculated using current prices in effect at the time, and this GDP is referred to as nominal GDP. The nominal GDP is adjusted by the economy-wide inflation indicator (-the GDP deflator) to compute the real GDP, which is used to compare economic activity across time periods.
When an economy has inflation, the nominal GDP (as well as nominal GDP growth) is higher, and the nominal GDP is deflated to estimate the real GDP (or real GDP growth). When an economy is in deflation, however, nominal GDP is lower than real GDP. According to recent estimates, this was the case for the Indian economy in Q2 FY16, with a real GDP of 7.4%. The nominal GDP, on the other hand, is only 6.0 percent.
It’s worth remembering that the nominal GDP captures the economy in which we live, earn, and spend. The present rate of nominal GDP growth is one of the lowest in a decade. This is reflected in corporate performance, which is perhaps at an all-time low. Furthermore, other indicators of economic health, such as industrial loan growth, are in the single digits, which is unheard of. Most people believe that deflation is as dangerous as, if not more dangerous than, high inflation for a rising economy. This normally necessitates a significant fall in the central bank’s interest rate.
Similarly, the government may take coordinated measures to boost spending in order to avoid the economy falling into a “deflation trap.” Surprisingly, the RBI and the government in India are celebrating 7.4% actual growth, and the necessity to address ‘deflation’ is not readily apparent. In an ideal world, India’s real GDP growth rate would be 8%, with a nominal GDP growth rate of 5% and a GDP deflator of -3 percent in one of the next quarters. Some may rejoice at the return of “8% growth.” If this occurs, however, it will indicate that the economy has descended farther into deflation!
Indian inflation indicators are posing fresh challenges to monetary policymakers before the controversy over the new GDP Series (Base Year 2011-12) has died down. For several quarters, the Wholesale Price Index (WPI), which measures industrial inflation, has seen negative growth (deflation). Consumer price inflation, on the other hand, has remained stable in the 4 percent to 6 percent range since 2013-14. The GDP deflator has more closely tracked the WPI in the past, as it did in the past. Given the sustained deflationary trend in the WPI, India’s GDP deflator could remain negative, signaling deflationary pressure on the economy. The CPI, on the other hand, may continue to show readings in the range of 4% to 5%.
The Urjit Patel Committee Report’s recommendations have been implemented by the RBI. The Consumer Price Index (CPI) is used as the nominal inflation anchor in the report. As a result, RBI’s monetary policy choices will be based on the CPI as a gauge of inflation. The period of analysis used by the Urjit Patel committee did not yield such a long period where WPI (together with GDP deflator) varied so considerably from CPI. However, like with most economic statistics, it’s dangerous to conclude that simply because something hasn’t happened before, it won’t happen again.
The present GDP deflator indicates that the economy is probably approaching a deflationary phase, despite the fact that the CPI continues to show somewhat strong inflation. The economy may slip further into deflation if the RBI continues to focus solely on CPI as an inflation metric (as recommended by the Urjit Patel Committee Report) and ignores the GDP deflator entirely. The consequence is that corporate earnings and debt servicing ability, both of which closely track nominal GDP, will continue to deteriorate, while inflation adjusted GDP (or real GDP) may continue to rise at a rate of 7% or higher.
If the CPI remains substantially above 4%, the RBI may claim this as a justification to keep the interest rate unchanged. With the GDP deflator in negative territory, India’s real interest rate (nominal interest rate minus systemic inflation) could be far above 8%, a figure not seen in more than a decade. Historically, India’s ‘high’ real interest rate has been around 6%. That means a rate cut of at least 100 basis points is possible. However, in order to make such a choice, the RBI must consider holistic measures of inflation across the economy, such as the GDP deflator, rather than relying solely on the CPI as a measure of inflation.
What causes GDP to rise or fall?
The external balance of trade is the most essential of all the components that make up a country’s GDP. When the total value of products and services sold by local producers to foreign countries surpasses the total value of foreign goods and services purchased by domestic consumers, a country’s GDP rises. A country is said to have a trade surplus when this happens.
What factors influence GDP growth?
Economic development and growth are impacted by four variables, according to economists: human resources, physical capital, natural resources, and technology. Governments in highly developed countries place a strong emphasis on these issues. Less-developed countries, especially those with abundant natural resources, will fall behind if they do not push technological development and increase their workers’ skills and education.
What happens to real income when real GDP rises?
Finally, evaluate the consequences of a rise in real gross domestic product (GDP) (GDP). Such an increase indicates that the economy is growing. As a result, looking at the implications of a rise in real GDP is the same as looking at how interest rates will change as a result of economic expansion.
GDP may rise for a variety of causes, which will be examined in more detail in the next chapters. For the time being, we’ll assume that GDP rises for no apparent reason and explore the implications of such a development in the money market.
Assume the money market is initially in equilibrium with real money supply MS/P$ and interest rate i$ at point A in Figure 18.5 “Effects of an Increase in Real GDP.” Assume, for the sake of argument, that real GDP (Y$) rises. The ceteris paribus assumption states that all other exogenous variables in the model will remain constant at their initial values. It means that the money supply (MS) and the price level (P$) are both fixed in this exercise. People will need more money to make the transactions required to purchase the new GDP, hence a growth in GDP will enhance money demand. In other words, the transactions demand effect raises real money demand. The rightward change of the real money demand function from L(i$, Y$) to L(i$, Y$) reflects this rise.
Does real GDP rise in tandem with aggregate output?
An increase in GDP does not always imply that a country has produced more output; the type of GDP in question must be identified. An increase in nominal GDP may simply indicate that prices have risen, whereas an increase in real GDP indicates that output has risen.