Economic Growth vs. Recession

Economists use Gross Domestic Product to determine the size of any economy. Since economists can measure the size of GDP over time, we can know how it changes. If we can see how the GDP grows or shrinks over time, then we can know if the economy is growing or shrinking, expanding or contracting.

Growth and Contraction

Let’s use some made up data to understand the concept of economic growth and recession. Remember, economic growth happens when GDP increases, and recessions happen when economies shrink.

Let’s say that GDP for our example economy is $100 this year. This means that the economy produced $100 worth of goods and services. Next year, the GDP is $103. From this, we can determine that the economy grew by $3, or 3% from year to year. The economy is growing, not very quickly, but it’s growing! There were more goods and services produced in this economy this year than last year.

Now what if the GDP were to fall back to $100 the next year? We would have experienced an economic contraction—the economy shrank by 2.91% from $103 back to $100. In an ideal world, the GDP for any one country would be going up year after year after year, but this isn’t always the case.

Inflation and Economic Growth

We use inflation rates to help us determine what part of the economic growth is “real.” That is, we want to know how an economy actually grew, not how much an economy grew due to rising prices.

We have two different types of GDP. There is nominal GDP, which is not inflation adjusted. And then there is real GDP, which is inflation adjusted. Let’s go back to our easy-to-understand number of $100.

If an economy grows from $100 one year to $103 the next, then there was a nominal GDP increase of 3%. To get the real rate of economic growth, we would remove inflation from the numbers. So, if inflation was 1% during this year long period, then the real rate of economic growth is equal to 3% minus 1%, for a real rate of 2% this year.

Real growth is an increase in the stuff that is being produced, and the services that are provided—not just an increase in prices. If prices just go up, then the economy isn’t more productive, or bigger, it’s just more expensive. This is why we remove inflation from economic growth to determine what part of the expansion is “real.”

Recessions

Now more than ever, the world is focused on the word “recession.” In many places around the world, recession came on strong following the financial crises that took place from 2008-2011.

As commonly defined, a recession is any period in which an economy shrinks for more than two consecutive quarters. We’ve focused on GDP growth or shrinkage from year to year, but a recession can happen within the same year.

When the economy shrinks for two quarters of a year (6 months, or 180 days) we start hearing about how an economy is in “recession.” Recession isn’t good—it means that the economy isn’t as productive at one time as it was during another.

We don’t like to see an unproductive economy; we want to see growth. However, as foreign exchange traders, we have the ability to make money during recessions by betting against currencies from countries with shrinking economies by exchanging weakening currencies for strengthening currencies.