Macroeconomics: Does real GDP goes lower than the nominal GDP when a period of inflation has begun?

Question

Macroeconomics: Does real GDP goes lower than the nominal GDP when a period of inflation has begun?

Answer 1

The short answer is: yes it does.

Usually, it's the growth rate in GDP that we discuss. Real GDP is the inflation-adjusted GDP while nominal GDP is just the GDP using present-day prices. The Fisher equation is an easy way of estimating the growth rate of the real GDP, which is:

Real GDP = Nominal GDP - Inflation rate

Let's take an example, say an economy grew 5% in nominal terms, but inflation also rose 2%, what is the real GDP, and will it be lower than 5%?

Real GDP Growth rate = 5 - 2 = 3%

If inflation rises, the real GDP growth rate will fall, so in this respect, increasing inflation real GDP always grows less than the nominal GDP when there is inflation.

Another way you might see this problem is by calculating the GDP in real and nominal terms. Here's how to do that:

Nominal GDP = Present Period Prices X Present Period Quantities

Real GDP = Base Period Prices X Present Period Quantities

Nominal GDP and Real GDP will always be the same in the base year and if there is inflation, you can compare the real and nominal GDP and even use this to calculate a GDP deflator.