Compound Growth vs Compound Interest
How are compound growth rates and compound interest rates related?
Written by J. Mance Gordon
Updated at April 23rd, 2024
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How are compound growth rates and compound interest rates related?
The formula for GDP growth rates over different periods of time is exactly the same as the formula for how a given amount of financial savings grows at a certain interest rate over time, as presented in Choice in a World of Scarcity. Both formulas have the same ingredients:
• an original starting amount, in one case GDP and in the other case an amount of financial saving;
• a percentage increase over time, in one case the GDP growth rate and in the other case an interest rate;
• and an amount of time over which this effect happens.
Recall that compound interest is interest that is earned on past interest. It causes the total amount of financial savings to grow dramatically over time.
Similarly, compound rates of economic growth, or the compound growth rate, means that we multiply the rate of growth by a base that includes past GDP growth, with dramatic effects over time.
Another way to calculate the growth rate is to apply the following formula:
Future Value = Present Value × (1 + g) n
Where “future value” is the value of GDP at the future date
“present value” is the starting GDP amount
“g” is the growth rate,
“n” is the number of periods for which we are calculating growth.
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