Monday, September 1, 2008

Nominal vs. Real GDP: Why the GDP Deflator Overstates GDP

To better illustrate the impact of the Import GDP Deflator on Real GDP, the chart below shows Real vs. Nominal GDP by component.

First, a refresher... the greater the size of net exports, the greater the GDP. Net exports = exports less imports, thus an increase in imports negatively impacts GDP all else equal.

So what do we find? Nominal imports increased in Q2 by 18.8% annualized. Real imports DECREASED in Q2 by 7.5% annualized. In other words, even though we paid 18.8% more out of our pockets, we received 7.5% less units of these imports. Why? The Import GDP Deflator decreased imports by more than 25%.

Is paying more for less beneficial to our economy? No... but it is good for GDP. As detailed here, this 25% contribution by the import portion of the GDP Deflator increased Real GDP by a positive 4.6% (Imports make up roughly ~1/6 of GDP). Had we paid the same price level quarter over quarter for our imports, and thus received more given the level of nominal GDP, real GDP would have been -1.3% (I understand this WOULD NOT necessarily be a more accurate version of GDP, but it illustrates the size of the impact / just how odd this calculation is).

Ignoring the odd calculation, does this make sense to me? It doesn't. For this to make sense, it must be reasonable that we imported 39.2% less petroleum products during the quarter (in real terms) on an annualized basis. If the U.S. was able to drop its dependence by that much in just one quarter, I guess the U.S. isn't nearly as dependent on the Middle East as we thought. More important, it implies that the U.S. economy is stronger because we paid more in aggregate for our imports, but received less units as more was consumed from non-imports.

Want to hear something more likely? The impact of import inflation on the GDP Deflator is too high and GDP is overstated.