What Are GDP Price Deflators and Price Indexes as Economic Indicators

At the economy wide level, inflation is generally measured by GDP deflators. GDP deflators measure inflation across all sectors of the economy, taking into account changes in prices for consumer goods and services, business fixed and inventory investment, housing investment, government purchases, and exports and imports. While there are a number of variations for GDP deflators using different weighting and base year schemes, the two most commonly used GDP deflators are they implicit GDP deflator and the fixed-weighted GDP deflator.

The implicit GDP deflator is merely the ratio of nominal GDP to real GDP. Official GDP deflator numbers are set so that the base year deflator equals 100 rather than 1. With the implicit deflator, there are no fixed weights for the components. Each quarter, each component's weight depends on expenditure patterns for that quarter. Therefore, changes in the implicit GDP deflator do not solely reflect price changes but a combination of the effects of shifts in the composition of GDP and period to period price changes. In fact, the BEA emphasizes this characteristic of implicit deflators by not classifying implicit deflators as price indexes. In contrast, the BEA specifically classifies fixed weight GDP deflators as price indexes.

The fixed weighted GDP deflator has fixed weights for the components based on expenditure shares in the base year. As such, component weights are fixed, but the relative importance of each component changes over time, depending on relative inflation rates for each component subsequent to the base year. Percentage changes in the fixed weighted GDP deflator reflect only price changes. The drawback for this deflator is that it does not keep up with changes in expenditure patterns and may not be as relevant in the current year as in the base year.

While GDP deflators measure prices for the domestic economy, it is not accurate to say that these prices measures exclude the effects of import prices. Exports and imports, as well as all components of nominal and real GDP, enter the calculation for GDP deflators. Expenditures on imports technically are subtracted from both nominal and real DGP to derive deflator numbers, but imports also make their way into other expenditure measures, including PCEs, PDEs, inventories, and even government purchases. Also, import prices enter these other components with lags when the imported goods or services are inputs rather than for final consumption. It would be incorrect to say that GDP deflators are unaffected by import prices. First, imports, nominal and real, are part of the formula for calculating these components in GDP. Finally, imports provide competitive price pressure for domestically produced goods and thereby affect prices of domestically produced goods. Whether import prices show up more readily in the CPI goods component or the GDP goods deflator is an empirical question, not entirely one of definition.

"Economic Indicators: Consumer Price Index." Investopedia.
"GDP Price Deflator." AmosWEB.