The Historical Trend

GDP Price Deflator

• From 1974 to 1981, the GDP price deflator experienced a steep rise. This was a period of high inflation rates associated, at least in part, with tremendous increases in petroleum prices. While modest inflation tends to be a natural part of the U.S. economy, the high inflation experienced during the 1970s exceedingly rare.

Common Uses

• Price Level Indicator: The most common use of the GDP price deflator is as an indicator of the economy's price level, and perhaps even more importantly, as a means of estimating the rate of inflation. The CPI-based inflation rate may be more widely reported by the media, but the GDP price deflator is usually the measure of choice when economists need precision in the analysis of inflation and related macroeconomic phenomena. While the GDP price deflator is not reportedly as frequently as the CPI (quarterly versus monthly), it does provide a more comprehensive measure of the price level and thus inflation. This is why the aggregate market analysis uses the GDP price deflator to measure the price level.


• Deflating Nominal to Real: Economists, business leaders, and government policy makers often find it useful to convert current, or nominal economic indicators to real terms, that is to eliminate any inflationary increases of the nominal values. In fact, the "deflator" part of the GDP price deflator comes about because it is used to deflate nominal GDP to real GDP.

Deriving the Deflator

Estimating nominal and real GDP are quite involved, to say the least. However, once real and nominal GDP have been meticulously estimated, the derivation of the GDP price deflator is relatively straightforward. This equation indicates how simple it is, divide nominal GDP by real GDP, then multiply by 100:

GDP price deflator

=

nominal GDP real GDP

x 100

For example, nominal GDP in 2002 was $10,480.8 billion and real GDP in 2002 (using 2000 prices) was $10,083.0 billion. The ratio of nominal to real (after multiplying by 100) is 103.95.

GDP price deflator

=

$10,480.8 $10,083.0

x 100

=

103.95

The interpretation of this 103.95 value for GDP price deflator in 2002 is that the average price level in the economy increased by 3.95 percent from 2000 (the base period for estimating real GDP) to 2002. Calculating the percentage change the GDP price deflator from one year to the next, then provides an excellent measure of the inflation rate. For example, the GDP price deflator is 102.38 for 2001 and 103.95 for 2002, a change of 1.54 percent.

A Family of Measures

• Implicit Deflators: In the same way that the GDP price deflator is derived as the ratio of nominal GDP and real GDP, a national income price deflator (NI price deflator) can be derived as the ratio of nominal NI and real NI. Similar price deflators can be derived for virtually every other measure in the National Income and Product Accounts, including net domestic product, personal income, gross national income, personal consumer expenditures, gross private domestic investment, to name just a few. However, other than a few of the comprehensive measures, like GDP and GNP, price deflators for other measures are not regularly reported by the BEA. But they are very easy to calculate.


• Chain-Type Price Indexes: The second set of price indexes, which are regularly reported by the BEA, are chain-type price indexes. These indexes are used to derive real measures of GDP, national income, consumption expenditures, etc. For the most part, chain-type price indexes and implicit price deflators have nearly equal values for a given measure. For example, the 2002 chain-type price index for GDP was 103.95, compared to a GDP price deflator value of 103.95.

Pros and Cons

• First, the GDP price deflator is based on ALL production in the aggregate economy. This is a definite pro. It includes not just urban consumption, as does the CPI, but also investment expenditures for capital goods, purchases by the government sector, and even exports to the foreign sector. It has it all. So for anyone truly interested in a price index for the aggregate economy, this is it.


• Second, the GDP price deflator measures the prices of "current production", the prices of goods actually produced during the current year. This also a definite pro. The CPI, in contrast is based on a market basket of goods identified 5 or 10 years earlier. Again, from a macroeconomic perspective, this is a much better way to go.


• Third, the GDP price deflator is reported quarterly, every three months, along with other measures in the National Income and Product Accounts. The GDP price deflator for the first three months of the year (January, February, and March) is not available until late April or May. And then, it is only a 3-month average rather than a month-by-month, blow-by-blow price index. From a timeliness perspective, the GDP price deflator comes up short on providing decision makers with the information needed.