Transcript GDP Deflator versus CPI Index

GDP Deflator vs. CPI Index
Two price indices to measure Inflation
GDP Deflator
• Purpose:
Converts Nominal GDP into Real GDP
– Nominal– Real-
absolute dollars from that year
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
Percent
per Year
15
Oil Spikes
raises CPI more
than GDP
Deflator
CPI
10
Conclusion: Oil is a bigger % of
the CPI Index than GDP Deflator
GDP deflator
5
0
1965
1970
1975
1980
1985
1990
1995
2000
2005
GDP Deflator math is similar to CPI Index
GDP Deflator Index
Real GDP =
= Nominal GDP
Real GDP
Nominal GDP X
Price Index
100
Base Year will always be 100
X 100
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