What is GDP Deflator?

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In this article, we are going to discuss what is GDP Deflator and how to calculate it. The GDP Deflator is also known as GDP Price Deflator or Implicit Price Deflator. It measures the impact of inflation on the gross domestic product during a specified period, usually a year.

How To Calculate GDP Deflator?

Introduction

In this article, we will discuss what is GDP Deflator and how to calculate it. After going through this blog, you won’t hesitate when someone asks you,” Define GDP deflator”. This post will answer all your questions.

The GDP Deflator is equal to GDP Price Deflator or Implicit Price Deflator. It measures the impact of inflation on the gross domestic product during a specified period, usually a year.

Meaning

The GDP deflator meaning,  the GDP Price Deflator considers both the nominal GDP and the real GDP of an economy. As discussed in our earlier article, the Nominal GDP represents the value of the finished goods and services that an economy has produced without considering inflation. Whereas the Real GDP means the value of the finished goods and services, an economy has grown, adjusted for inflation. Thus, GDP Deflator is a factor by which Nominal GDP is adjusted to calculate Real GDP. It changes gross domestic product by removing the effect of rising prices, ie. Inflation. It shows how much an economy’s GDP is growing. Therefore, if there were no inflation involved, the nominal GDP would equal the real GDP. The GDP price inflator calculates the impact of inflation on the finished goods and products by converting an economy’s output into current prices, thereby demonstrating the effect of inflation on the GDP change.

It measures price inflation/deflation concerning a specific base year. The GDP deflator of the base year is equal to 100. Since it is relative to the base year, it will tell us how adjusted the prices are. If there has been inflation, the GDP deflator would be more than the base year prices, and if there is deflation, it would be less.

What is GDP Deflator?

GDP Deflator Formula

The GDP Deflator Calculator is as follows: (Nominal To Real Formula)

·  GDP Deflator = (Nominal GDP / Real GDP) * 100,  where

·  Nominal GDP = GDP evaluated using current market price

·  Real GDP = GDP evaluated using base year price (Inflation-adjusted GDP)

In this formula, figure 100 indicates the base year price to interpret the relative data easily.

Example

By referring to the above formula, we would calculate the Implicit Price deflator for 2017. The base year is 2012, where the Implicit Price deflator is 100.

·  Nominal GDP= Rs 152.51 Trillion

·  Real GDP= Rs 121.90 Trillion

·  GDP deflator = (152.51 / 121.90) * 100 = 125.10

So, the GDP deflator is 125.10, compared to the base year price of 100. This means that the aggregate level of prices increased by 25.1% from the base year (2012) to 2017. Please remember GDP deflator is always calculated in Rupees GDP value to avoid exchange rate impact. This is because an economy’s real GDP is calculated by multiplying its current output by its prices from a base year. So, the GDP deflator will help identify how much prices have inflated over a specific period.

Importance of GDP Deflator

  1. Apart from GDP Deflator, there are other measures of inflation like Consumer Price Index (CPI) and Wholesale Price Index (or WPI). However, GDP deflator is a much broader measure than CPI and WPI.
  2. Since Gross Domestic Product is an aggregate measure of production, being the sum of all final uses of goods and services (fewer imports), GDP deflator reflects the prices of all domestically produced goods and services in the economy. Other inflation measures like CPI and WPI are based on a limited basket of goods and services, thereby not representing the entire economy.
  3. The GDP deflator also includes the prices of investment goods, government services, and exports and excludes the cost of imports. At the same time, the basket of WPI (at present) has no representation of the services sector.
  4. Changes in consumption patterns, introducing new goods and services, or structural transformation are automatically reflected in the deflator, which is not the case with other inflation measures (CPI & WPI).

However, WPI and CPI are available every month, whereas deflators come with a lag (yearly or quarterly, after quarterly GDP data is released). Hence, the monthly change in inflation cannot be tracked using a GDP deflator, limiting its usefulness.

Practical Example – GDP Deflator of India

The below graph shows the GDP Deflator of the Indian Economy:

GDP Deflator of India

Source: Tradingeconomics.com

  • As can be seen, the GDP deflator is steadily increasing from 2012 and is at 128.80 points for 2018. A deflator above 100 indicates price levels being higher compared to the base year (2012 in this case). Inflation doesn’t need to occur, but one can experience deflation after a period of inflation if prices are higher than the base year.
  •  In the above graph, the base year was changed in 2012 to reflect the economy better as it would cover more sectors. Before that, the base year was 2004-05, which required change.
  • Since India is a rapidly growing economy with dynamic changes to its policy, the mentioned changes were essential. Also, the increasing deflator reflects a steady increase in inflation due to continuous growth opportunities.
  • As per World Bank Reports for 2017, India ranks 107 on the list of GDP Deflators and the inflation rate for the same is 3%. This can be stated as a comfortable position compared to countries facing hyperinflation, such as South Sudan and Somalia. On the contrary, it also does not meet the threat of deflation such as Aruba and Liechtenstein. Hence, it is essential to keep it at manageable levels.
  • The RBI has adopted the CPI as a nominal inflation anchor. During 2016, the GDP Deflator suggested that the country enter a deflation zone while CPI exhibits a moderately high inflation level. Such situations can push the economy into deflation, with the implication that corporate earnings and debt servicing ability that closely tracks Nominal GDP will keep on deteriorating. In contrast, inflation-adjusted GDP (Real GDP) may continue to exhibit a growth rate of over 7%.

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