Question

If inflation rate increases, real GDP will decrease.

The statement is true, false or maybe? And explain it.

Answer 1

The statement is false, If inflation rate increases then real GDP also increases.

Real GDP, also known as inflation-adjusted gross domestic product, measures the value of finished goods and services at constant base-year prices, i.e. it measures the value of output producing during a period using prices of a base year.

Relationship between GDP and Inflation

When the economy is healthy, there is usually low unemployment and wage increases, as businesses demand labor to meet the growing economy.

Due to low unemployment and increase in wages, there is an increase in the purchasing power of people. This leads to an increase in demand for goods and services, which leads to an increase in general price levels.

Hence Inflation will Increase due to an Increase in GDP.

However, if the GDP growth rate is speeding up too fast, the Federal Reserve/Reserve Bank may raise interest rates to stem inflation—or the rising of prices for good and services. That could mean loans for cars and homes would be more expensive. Businesses too would find the cost of borrowing for expansion and hiring to be on the rise. In short, the Federal Reserve/Reserve Bank will try to remove some money from the economy to reduce the spending power of people, and gain a control on the rising general prices. A fall in the purchasing power will lead to a fall in demand, which will lead to a fall in production, resulting in a fall in the GDP of the nation.