GDP in taka or dollars represents the same reality

Several stories in the media have recently drawn attention to the "weaker" value of GDP per capita measured in dollars, expressing concern that exchange rate depreciation siphons off output growth.  Nothing could be further from the truth.

Let me illustrate with an extraordinarily simple example.  Imagine an economy that produces only one good, let's say jackfruit. Suppose in 2023 this economy produced 100 jackfruits.  To simplify further, let us assume no intermediate goods such as fertilizer are used to produce jackfruit.  The value of jackfruit and the "value added" in jackfruit are therefore the same.

Suppose each jackfruit sold for Tk100 in 2023. So the nominal GDP was 100 jackfruits times Tk100 per jackfruit = Tk10,000 in our hypothetical economy in 2023. Let's suppose the base year is also 2023, thus making the real GDP (measured in constant 2023 prices) the same as the nominal GDP in 2023.  Suppose the exchange rate was Tk99.46/$.  Thus GDP in dollars in 2023 was $100.54 (Tk10,000 divided by Tk 99.46/$).

Now suppose in 2024 this economy produced 106 jackfruits and the price increased to Tk110 per jackfruit.  The nominal GDP is therefore Tk11,660, implying a nominal GDP growth of 16.6%.  However, if we value 2024 production of jackfruits in constant 2023 price of Tk100 per piece, the real GDP is Tk10,600, implying a real GDP growth of 6%. This reflects the simple fact that the economy produced 6 more jackfruits in 2024 relative to 2023.

Assume now that the exchange rate depreciated from Tk99.46/$ in 2023 to Tk109.97/$ in 2024. The value of nominal GDP in 2024, measured in dollars, is therefore $106, implying only 6% nominal growth, compared with 16.6% nominal growth when measured in taka. Exchange rate depreciation erased 16.6% - 6% = 10.6% nominal growth. Did it destroy any jackfruit the economy produced? Obviously not!

A good, albeit far less than perfect, analogy is that 40 degree Celsius is as hot as 104 degree Fahrenheit, not an iota more or less.  The two differ only in units of measurement. The reason it is far less than perfect is that the relationship between Celsius and Fahrenheit is forever fixed.  Not so for the relationship between currencies.

Notice the price of jackfruit in dollars was 1.005 (Tk100/Tk 99.46/$) per piece in 2023. Suppose this economy exported 10 jackfruits at this price, earning $10.05 in export revenues in 2023. Recall the price of jackfruit increased to Tk 110 per piece and the exchange rate depreciated to Tk109.97/$ in 2024.  So the dollar price of jackfruit  is $1.00027 in 2024, about 0.5% lower per piece than in 2023. Suppose because of the lower price, export increased to 11 jackfruits in 2024, hence fetching $11 in export revenues, compared with $10.05 in 2023. This is a real change, not just a change in the unit of measurement.

Moral of the story: Exchange rate depreciation does not depreciate real output.  Comparing GDP (total or per capita) over time in nominal dollars or, for that matter, in nominal taka is meaningless. Such comparisons conflate price (nominal) and quantity (real) changes. They are tantamount to comparing the proverbial "apples" and "oranges".  

This is not to suggest that exchange rate changes do not matter. They do matter not because they change the accounting but when they change relative prices in international trade and finance. That is a whole different story.

You may wonder why then national and international agencies report calculations such as GDP per capita in nominal dollars? They do so to facilitate cross country comparisons of income per capita or size of the GDP. Even such comparisons, based on conversions using nominal exchange rates, can be misleading because they do not always reflect differences in price levels between countries.

This can be corrected by using purchasing power parity (PPP) conversion rates which adjust for differences in costs of living across countries by assessing how much of a common currency (often the US dollar) is needed to buy the same quantity of goods and services in different countries. The idea is that a given amount of international dollars should buy roughly the same amount and quality of goods and services in any country.

Unfortunately data on PPP exchange rates are not as readily and as frequently available as nominal exchange rates because unlike the later, PPP exchange rates are not observable.  So the practice, despite the pitfalls, is to use the nominal exchange rate for conversion into a common currency.