GDP Deflator vs. CPI Index
Two price indices to measure Inflation
GDP Deflator
• Purpose: Converts Nominal GDP into Real GDP – Nominal- absolute dollars from that year
– Real- inflation adjusted dollars from base year• Real dollars also called “Constant Dollars “
• Only real GDP reflects true quantity of goods/services produced
If Real GDP => you are making more goods/services
GDP Deflator vs. CPI Index
• Both measure inflation but two important differences often cause them to diverge
• GDP deflator reflects prices of all goods/services produced domestically – broader index than CPI but excludes imports
• CPI index reflects prices only a market basket of some goods/services bought by consumers – Narrow, consumer index, but includes imports
Two Measures of Inflation Diverge
1965
Percentper Year
15
CPI
GDP deflator
10
5
01970 1975 1980 1985 1990 20001995 2005
Oil Spikes raises CPI more
than GDPDeflator
Conclusion: Oil is a bigger % of the CPI Index than GDP Deflator
Nominal GDP Real GDP
X 100GDP Deflator Index =
Base Year will always be 100
GDP Deflator math is similar to CPI Index
Real GDP = Nominal GDP X 100 Price Index
Why Inflation is Bad?
• Difficult for Business to plan for future– price goods/services unclear
– Investment becomes difficult
• Lowers value of U.S. currency
• Lowers purchasing power (real value of money)
• Raises long term interest rates– Bond buyers need more nominal interest!
Formula Sheet
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