Gross Domestic Product (GDP) is the total monetary or market value of all finished goods and services produced within a country in a given period. As a broad measure of total domestic production, it is a comprehensive scorecard of a country’s economic health.
GDP is a key tool that guides policymakers, investors, and businesses when making strategic decisions. The calculation of a country’s GDP encompasses all private and public consumption, and government outlays, investments, additions to private inventories, paid-in construction costs, and the foreign balance of trade (exports are added to the value and imports are subtracted). GDP data is usually published in percentage terms by the country’s Department of National Statistics. Most countries publish GDP data every month and quarter.
GDP can be calculated on a nominal or real basis, with the latter taking inflation into account. But more often, real GDP is used because it is the best method for expressing a country’s long-term economic performance. Government institutes, such as the US Federal Reserve, use growth rates and other GDP statistics in their decision-making process when determining the type of monetary policy.
When does a country’s GDP rise, and when does it fall?
Among all the components that make up a country’s GDP, it is crucial to keep an eye on the foreign trade balance. If the total value of goods and services that domestic producers sell to foreign countries exceeds the total value of foreign goods and services that domestic consumers buy, then there is a trade surplus. In such a situation, the country’s GDP tends to grow.
If the opposite situation occurs - if the amount that domestic consumers spend on foreign products exceeds the total amount that domestic producers can sell to foreign consumers - this is called a trade deficit. In such a situation, the country’s GDP tends to decline.
How to read the GDP data?
The GDP data should be evaluated on two levels. The first is to estimate the dynamics of GDP from month to month, quarter to quarter. The second is to compare the actual value with the forecasted one.
In general, if the growth rate is slowing, countries’ national central banks can use soft monetary policy to stimulate the economy. If the growth rate rises, the central bank can use aggressive monetary policy to prevent inflation (what is happening now in most countries).
If the actual value is better than expected, it is usually positive for the country’s stock market and currency. Conversely, if the actual value is worse than expected, it is negative.
Let’s look at a concrete example. The month’s GDP report was released in Great Britain on Tuesday (July 13). The data showed that the UK economy grew by 0.5% last month. Analysts’ forecast was a decline of 0.2%. First, the economy’s growth by 0.5% overlapped the decline over the previous three months. Second - the actual data was better than expected. As a result, GBP/USD quotes reacted with growth at the moment of news publication. Of course, the news is often manipulated, but the real economic data will always show the actual direction of financial instruments in the medium term.
