- What is GDP Deflator?
- How to Calculate GDP Deflator
- GDP Deflator Formula
- GDP Deflator vs. Consumer Price Index (CPI): What is the Difference?
- U.S. Implicit Price Deflator: Historical Graph
- Is CPI an Accurate Measure of Inflation?
- GDP Deflator Calculator
- 1. U.S. Nominal and Real GDP Economic Data
- 2. GDP Deflator Calculation and Analysis
What is GDP Deflator?
The GDP Deflator tracks the changes in the prices of all the goods and services produced within a country’s economy in order to measure its true economic state.
The GDP deflator, or “Implicit Price Deflator”, essentially removes the effects of inflation from a country’s gross domestic product (GDP) to isolate the underlying growth in productivity.
How to Calculate GDP Deflator
The GDP deflator is utilized by economists and those monitoring the health of a country’s economy, specifically in the context of measuring the risk of inflation.
In economics, the term GDP stands for the “gross domestic product” and represents the total value of all goods and services produced within a country over a pre-determined period.
However, the rate of inflation in a country – i.e. the pricing levels of goods and services – can muddy whether a country is actually experiencing positive, increased economic activity.
In order to consider that risk factor, the GDP deflator, i.e. the “implicit price deflator”, removes the effects of inflation from the metric.
In effect, isolating a country’s GDP growth from inflation more accurately reflects the incremental change in GDP attributable to productivity rather than rising prices.
GDP Deflator Formula
The GDP deflator is the ratio between nominal GDP and real GDP, multiplied by 100.
Expressed formulaically, the equation to calculate the GDP deflator is as follows.
Where:
- Nominal GDP ➝ The value of the goods and services produced within an economy produced before any adjustments for inflation.
- Real GDP ➝ The value of the goods and services produced within an economy after adjusting for inflation.
The measure brings attention to the change in nominal GDP caused by inflation (i.e. the rise in prices) instead of increased productivity.
Based on the equation, we can derive that the implicit price deflator is the factor by which the nominal GDP can be adjusted to estimate the real GDP.
The calculation of the implicit price deflator includes exports to other foreign countries, whereas imports from other countries are excluded.
Hypothetically, if there were no inflation in a country, the nominal GDP would be equivalent to the real GDP, but of course, that would be rather unrealistic.
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Enroll TodayGDP Deflator vs. Consumer Price Index (CPI): What is the Difference?
The consumer price index (CPI) is produced by the U.S. Bureau of Labor Statistics (BLS) and is arguably the most frequent measure of inflation.
The primary use case of the GDP price deflator and consumer price index (CPI) is virtually identical.
The GDP price deflator, however, is perceived as a more comprehensive measure of inflation than the CPI because it is not based on a fixed basket of consumer goods.
Like the consumer price index (CPI), the GDP price deflator is utilized to better understand the state of inflation within a country.
But while the CPI tracks the movement of prices of a selected basket of goods, i.e. commodities procured by consumers, the GDP deflator reflects the prices of all commodities and is thereby more inclusive of the pricing of goods produced domestically, as well as services.
- GDP Deflator → Prices of Commodities + Domestic Goods and Services
- Consumer Price Index (CPI) → Basket of Fixed Consumption Goods (i.e. Seldom Revised)
Therefore, the GDP deflator is a measure of a constantly “adjusting” basket of commodities, while the CPI is more indicative of the price movements of a fixed set basket of goods representative of consumer spending.
Usually, the findings derived from tracking the CPI and GDP deflator are within range, albeit the GDP deflator tends to be lower in practically all cases, given it is meant to be a more conservative measure.
U.S. Implicit Price Deflator: Historical Graph
Once computed, the implicit price deflators are compared to the base year, a pre-defined period that serves as the basis for historical pricing to determine if the change in GDP is, in fact, positive or negative.
The relevant data set is published on a quarterly basis by the U.S. Bureau of Economic Analysis.
The screenshot below is of the implicit price deflator in the U.S. as of September 29, 2022—from Q1-21 to Q2-22—with the next official release scheduled for October 27, 2022.
Gross Domestic Product (GDP): Implicit Price Deflator Graph (Source: FRED)
Is CPI an Accurate Measure of Inflation?
The consumer price index (CPI) is widely tracked to measure inflation and the cost of living in a country, but the estimation can include goods or services insignificant to most of society (or are perhaps outdated).
Contrary to the implicit price deflator, imports are in fact included in the CPI metric.
To calculate the CPI, only items picked to portray consumer spending are considered, so any heavy machinery or industrial equipment is ignored in spite of their crucial role in a country’s economic output, i.e. the priority is on consumption goods purchased by everyday consumers and not businesses.
GDP Deflator Calculator
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
1. U.S. Nominal and Real GDP Economic Data
Suppose we’re tasked with calculating the GDP deflator for the U.S. over the past couple of quarters, starting with Q1 of 2021.
The table below displays the historical economic data of the U.S., which was exported from FRED:
| Economic Data | Q1-21 | Q2-21 | Q3-21 | Q4-21 | Q1-22 | Q2-22 |
|---|---|---|---|---|---|---|
| Nominal GDP | $22,314 billion | $23,047 billion | $23,550 billion | $24,349 billion | $24,740 billion | $25,248 billion |
| Real GDP | $19,216 billion | $19,544 billion | $19,673 billion | $20,006 billion | $19,924 billion | $19,895 billion |
While we are using data from FRED, please note that our exercise is only meant for illustrative purposes.
There are various complexities surrounding the seasonally adjusted figures we’re using, and opinions on the correct process of computing GDP itself can vary. But for the sake of simplicity, we’ll rely on the numbers provided.
2. GDP Deflator Calculation and Analysis
Since we now have the required inputs for our formula, we can divide the nominal GDP by the real GDP in each quarter and multiply the resulting figure by 100 to calculate the GDP deflator.
In conclusion, we arrive at the following figures for the GDP deflator in the past six quarters in the U.S.
- Q1-21 → 116.1
- Q2-21 → 117.9
- Q3-21 → 119.7
- Q4-21 → 121.7
- Q1-22 → 124.2
- Q2-22 → 126.9
