GDP measures the economic output of a nation. It is a key indicator for policymakers who use it to gauge whether the economy is growing, stagnating or shrinking. Tracking GDP over time helps them decide whether a government should stimulate the economy by pumping money in or cool it down to avoid inflation. Central banks also monitor GDP growth when deciding interest rates and money supply.
However, GDP has its critics. For example, it doesn’t take into account the value of off-the-books activities such as underground market activity, black-market drug dealing or unremunerated volunteer work. GDP also doesn’t account for environmental damage or destruction of capital assets such as the collapse of the Lehman Brothers investment bank in 2008.
Inflation must be taken into account when comparing GDP over time. Using a statistical tool called a price deflator, the change in nominal GDP is adjusted to remove the effect of changing prices. This is done to make the comparison fair and allows us to see if GDP has gone up because more is being produced or because prices have risen.
The calculation of GDP is complex and difficult to get right. It is estimated each quarter by the country’s national statistical agency and then published. The data are often revised as new information becomes available, and three estimates of GDP are released each month (the advance estimate, the second revision and the third revision). This allows for greater accuracy over time. The numbers are also converted to the purchasing power parity (PPP) exchange rate when comparing between countries, to remove the effects of differences in currency.