The inflation rate is crucial for assessing economic performance and growth; therefore, it must be measured. The GDP Deflator is useful in measuring inflation in an economy since it can track price changes and their impact on the gross domestic product of a particular country or locality. This will help economists and governments make informed decisions to stimulate the economy and try out new policies that might bring deflation into the economy.
So, how does one calculate inflation with a GDP deflator?
What is GDP Deflator?
GDP (Gross Domestic Product) Deflator is defined as the “measure of the level of prices of all new, domestically produced, final goods and services in an economy in a year” [Source]. It can be explained as a “measure of inflation. It is the ratio of the value of goods and services an economy produces in a particular year at current prices to that of prices that prevailed during the base year” [Source].
GDP is the “total monetary value of all final goods and services produced within the territory of a country over a particular period of time (quarterly or annually).” The GDP Deflator measures price inflation or deflation in a specific base year. It is calculated by dividing the nominal GDP by the Real GDP × 100. Nominal GDP measures a country’s gross domestic product using the current price without adjusting them for inflation, and Real GDP measures a country’s economic output after adjusting to the impact of inflation. It is called the deflator because “it’s also the percentage you have to subtract from nominal GDP to get real GDP.”
GDP deflator vs. CPI
GDP Deflator or an implicit price deflator is an “indicator of the impact of inflation on GDP in an economy, or it merely notes the price changes in an economy in one year” [Source]. CPI (Consumer Price Index) is a “price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time” [Source].
GDP Deflator focuses only on domestic goods and excludes imported commodities. This differs from CPI, which tends to factor in anything bought by consumers, including foreign goods or services. Another difference between GDP Deflator and CPI is that GDP Deflator measures the prices of all goods and services while CPI tends to measure goods only bought by consumers [Source].
The GDP Deflator measures an ever-changing basket of commodities, but CPI focuses on indicating the price of a fixed representative basket [Source]. Also, GDP Deflator frequently changes weights, and CPI is revised very infrequently.
How to calculate Inflation based on GDP deflator
To calculate inflation based on GDP Deflator, the following formula is used: Inflation = (GDP of Current Year – GDP of Previous Year) / GDP of Previous Year [Source].
Is the GDP Deflator the same as the Inflation Rate?
GDP deflator measures inflation, which is different from the inflation rate. The inflation rate is the rate at which prices change as they increase.
How to calculate GDP Deflator
To calculate the GDP Deflator, the following formula is used: GDP Deflator = Nominal GDP ÷ Real GDP × 100.
How to calculate the Inflation Rate using Nominal and Real GDP?
The inflation rate can be calculated using nominal and real GDP through this formula: GDP Deflator = Nominal GDP ÷ Real GDP × 100.
How to calculate the Inflation rate given Nominal GDP and GDP deflator
The inflation rate can be calculated using the nominal GDP and GDP Deflator by finding the Real GDP first by this formula: Nominal GPD ÷ GDP Deflator. Then use the above formula to get the inflation rate.