chain

A method used to determine real gross domestic product (GDP) that accounts for changes in relative prices over time is the calculation based on chained dollars. Instead of using fixed prices from a single base year, this technique averages GDP growth rates using prices from two adjacent years. To illustrate, consider calculating real GDP growth between 2022 and 2023. The process involves weighting the quantities of goods and services produced in 2022 by 2022 prices, and also weighting the quantities of goods and services produced in 2023 by 2023 prices. Then, the quantities of both years are weighted by the prices of 2022, and again by the prices of 2023. The geometric average of these two growth rates (based on each year’s prices) is then used to estimate the real GDP growth. These annual changes are then chained together to form a time series, indexed to a specific base year. This series provides a more accurate measure of economic growth by minimizing the distortion caused by using prices that become increasingly outdated.

This methodology mitigates the substitution bias inherent in fixed-weight GDP calculations. Fixed-weight measures tend to overstate growth when prices of goods and services that consumers buy in greater quantities increase more slowly than others. This also tends to understate growth when the price of goods and services that consumers buy in smaller quantities increase more slowly. The use of chained dollars offers a more accurate reflection of the economy’s actual output over time, making it a valuable tool for economic analysis and policy decisions. Previously, relying on fixed-weight measures introduced significant inaccuracies, particularly over extended periods. As relative prices shifted substantially, these fixed-weight measures became less reliable indicators of true economic activity.

Read more