The GDP and currency strength are closely related, with changes in a nation’s GDP directly or indirectly affecting its currency strength. In this post,the relationship between the two will be examined.
What is GDP?
The gross domestic product or GDP of a nation is a measurement of the monetary value of its total economic output. This is usually done within a stipulated time period. This time period can be annually or quarterly.
The GDP of a country can be calculated by taking into account the following parameters. They are:
- Consumer spending (C)
- Business investment or capital expenditures (I)
- Government consumption expenditures (G)
- Net export (X – M) which is given by total exports (X) – total imports (M)
The formula for calculating GDP is as follows:
GDP = C + G + I + (X – M)
Classification of GDP
GDP can be calculated in different ways, by taking into account conditions such as inflation and population. The different types of GDP measurements are nominal GDP, real GDP and GDP per capita.
Nominal GDP: Nominal GDP of a country is calculated using raw data with no modifications.
Real GDP: This type of measurement is adjusted for inflation. It is usually gotten from the nominal GDP by dividing it with a GDP deflator. The GDP deflator is calculated by taking the difference between the prices in the current year and that of the base (reference) year.
GDP per capita: This is calculated from the nominal GDP by dividing it with the country’s population. It is used in fairly equalizing the GDP of different nations for the purpose of comparison. Real GDP per capita can be calculated by dividing the real GDP by the population.
GDP and Currency Strength
The GDP being a measure of a nation’s economic strength can impact the value of its currency significantly. GDP can impact the value of a nation’s currency in three ways.
To start with, the first way the GDP can affect the value of a nation’s currency is through being an indicator of economic health. If the GDP of a nation increases, it points to a healthy economy, and hence the value of its currency rises. If the GDP drops or falls to the negative, it is a sign that the nation’s economy is receding. Therefore, the value of the nation’s economy drops.
Secondly, investors rank the GDP highly as a metric demonstrating economic health for investment. This is because it incorporates business expenditure. Also, in nations with an increasing GDP, investments grow. Therefore, if the GDP is high and increasing it encourages investment, which means more money in the economy. This causes a rise in the value of the nation’s economy because of the boost in its economy. The reverse is also possible when investors pull money due to bad GDP figures. You can learn more about how GDP affects the economic landscape of a country through investments and startups by reading this article.
Finally, a rapidly increasing GDP can be a result of inflation. This means the same amount of goods are produced at higher costs rather than more goods being produced. Central banks adjust(interest rates of the country to curb inflation. This then impacts the currency’s value. On the other hand, deflation can also cause a drop in GDP, prompting the central bank to adjust (cut) interest rates.
To learn more about how the interest rate of a nation affects the currency value, click here.
In conclusion, the GDP is a strong metric which greatly affects the currency value, as it is a measure of the economic strength. Therefore, it is one of the major fundamental tools of analysis in forex.
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