Thursday, August 28, 2008

Gap Between GDP Deflator and CPI Widest Since 1980

As we've detailed here and here, the GDP Deflator appears to overstate GDP by an incomprehensible (in my opinion at least) margin. How much? Well, one measure, CPI less GDP Deflator, shows the GDP Deflator is at its widest margin to CPI since 1980.


  1. Jake, that's a good chart. Alice Coo over at UK Bubble has noticed a similar gap between the UK's old RPI inflation measure and the new and 'improved' CPI version. Guess which one is lower?

  2. Jake - the details escape me but there are fundamental differences in what each is trying to measure. I seem to recall Econbrowser (Hamilton, Chin) reacting to this meme several months back when it started floating around and taking it down to bedrock. They also did a lovely job of explaining an defending the inflation calculations themselves in another post. Sorry I don't have the addresses. Don't know if you're open to discussion on this (Barry is not, at all) but the gist is that the GDP deflator is looking at the entire collection of goods and services and is built up from each of the line items. The CPI is looking only at a representative consumer's basket of goods. Which is not to say there's not likely some discrepancies but a simple algebraic comparison really doesn't cut it to the best of my understanding.

  3. There definitely are fundamental differences (for one the GDP deflator leaves out spikes in imports - i.e. oil). My counter is these costs become embedded into other goods and while the #'s initially look good in $$ terms, they are later revised down because productivity / demand dropped significantly from higher input prices.

    More specifically in response to Hamilton's post here:

    I responded with this (probably need to read his post first to get where I'm going with it):

    I think James' example is simple and his logic is easy to understand, but it isn't necessarily applicable to the real world (or specifically to the U.S.). James' story involves an Island which grows one good (a coconut, which it doesn't "produce") and imports oil.

    The U.S. does not have many "natural goods" like coconuts. Thus, we use that super-expensive imported oil as an input for our final goods. Thus, inflation has crept up as this expensive source of energy has flowed through the supply chain (YoY: energy up 70%+, PPI up 10%, CPI up 5%, Core CPI up 2.5-3%).

    A better example would have been coconuts and a fertilizer that is essential to grow coconuts. In this case had fertilizer doubled in price, I have feeling that $515.10 worth of coconuts would not have gotten you the 510 initially assumed by the Island's BEA in the first round of its Real GDP calculation, but rather only 470 as the higher price of fertilizer increased the price of the final good, hurting demand. Thus, rather than an increase in GDP from 500 to 510 coconuts, there was a recession to 470 (same nominal GDP in both cases).

    At the end of the day, we need to look at the numbers and ask ourselves if they make sense and 1.1% does not. Should the GDP Deflator be as high as that implied by the CPI? Probably not, but somewhere in between would cause another revision to GDP, which was my point all along...

  4. And whenever the gap metric has been greater than 2% (as it is now), we've had a nasty recession... And the current trend hasn't peaked yet...

  5. Perhaps more importantly, whenever the gap has exceeded the 2% level (1973-ish, 1980-ish), the stock market has fallend significantly further than it has so far in this bear market.