Exchange Rates and Dollar-Denominated GDP

An economy’s GDP is first measured in its domestic currency and can then be converted into US dollars for international comparison. For current-price GDP, dollar-denominated GDP equals nominal GDP in domestic currency divided by the exchange rate expressed as domestic-currency units per US dollar.

The arithmetic effect

Let E denote domestic-currency units per dollar. Then GDP in US dollars = domestic-currency GDP ÷ E.

• A depreciation raises E and reduces dollar GDP, other things remaining unchanged.
• An appreciation lowers E and increases dollar GDP, other things remaining unchanged.
• If domestic nominal GDP grows by 10 percent while the currency depreciates by 5 percent, dollar GDP grows by about 4.8 percent, because 1.10 divided by 1.05 is approximately 1.048.

What the change does and does not show

An exchange-rate-induced change in dollar GDP is primarily a conversion effect. It need not represent an equivalent change in domestic production or living standards.

• Real GDP may rise even while dollar GDP falls if currency depreciation outweighs domestic nominal GDP growth.
• Conversely, currency appreciation can enlarge dollar GDP without a corresponding increase in real output.
• Current-dollar GDP reflects domestic real growth, domestic price changes and exchange-rate movements; therefore, it should not be treated as a pure measure of real growth.

Economic effects beyond conversion

Exchange-rate movements can also influence GDP indirectly through trade, prices and expenditure, but these effects are not mechanical.

• Depreciation can make exports cheaper to foreigners and imports costlier domestically, although the outcome depends on demand responsiveness and production capacity.
• Higher import costs may raise domestic inflation and input costs, partly increasing nominal GDP while affecting real activity unevenly.
• For comparisons of domestic purchasing power, purchasing power parity conversion is often more informative because it adjusts for differences in national price levels.