The June GDP deflator in the US: Conspiracy theory edition

Over at the Big Picture, Barry Ritholtz has been constantly complaining that the GDP deflator is underestimating inflation. Well I’m not particularly surprised since the GDP deflator does not measure inflation persee.

His specific concern is that the rising oil prices have decreased the GDP deflator – he thinks this is ridiculous, however, if we are willing to stop being conspiracy theorists for a little while we will see that it is fine.

GDP=Consumption+Investment+Government Spending+Exports-Imports

As a result, if the volume of everything was unchanged (such that real GDP was unchanged) but import prices rose, nominal GDP would fall. As a result, rising import prices lower the GDP deflator (as this is what is used to adjust the nominal figure to a real figure). Since oil is imported, and since the imported price went up a lot over the June quarter, this drove the GDP deflator down.

Real GDP is a measurement of the volume of production in the economy, which is why this makes sense.

Now you may feel uncomfortable with the idea that higher oil prices increase GDP – and you would be right to be concerned, as deep down it doesn’t really make sense. However, it turns out this is consistent with the numbers – as the impact of higher oil prices doesn’t just turn up in the import figures. Higher import prices lower production in the economy – which is measures by reductions in consumption, investment, and exports.

Furthermore, as petrol is an input to production, the price of consumption, investment, and exports will increase – which is counted in the deflator. In this case, if we didn’t could the oil price increase in the deflator (as Barry Ritholtz doesn’t later on in the post) we would be DOUBLE COUNTING the oil price increase!

Ultimately, the low GDP deflator relative to the share of imports to the deflator implies to me that some of the increase in oil costs in the US have not been passed on to consumers – not that there is a government conspiracy to fudge the numbers.

6 replies
  1. Miguel Sanchez
    Miguel Sanchez says:

    Interesting to compare the US numbers with Canada, an oil exporter: on an annualised basis, which is how the US reports its numbers, the GDP deflator was +10.5% in June.

  2. Barry Ritholtz
    Barry Ritholtz says:

    Here’ was Sunday’s comments:

    “Understand that this is not a political issue, but rather, a quantitative analytical one, reflecting fair-to-poor econometric modeling, one with an inherent downside bias as to the inflation data, and an upside bias when it comes to GDP and job creation . . . ”

    The conspiracy claim sis the refuge of the lazy and ill informed . . .

  3. Matt Nolan
    Matt Nolan says:

    Hi Miguel,

    Exactly, a net exporter of fuel would have had a much larger GDP deflator than an net importer – as exports are a positive addition to GDP while imports are a detractor.

    Hi Barry,

    “GDP should measure what the total production in the USA — as it is, it does a rather poor job of it.”

    I just don’t agree with this – it is a good measure of “production”. Fundamentally, when we discuss production we are interested in finding some objective measure of the “volume” of production.

    We can’t do this so there are areas where the statistics agencies make subjective assumptions in order to achieve volumes. I often read your blog and have noticed that you criticise this often – and that it fine, subjective assumptions are an issue that we should always debate.

    However, in recent days I have noticed that you have been doing the following:

    a) calling the GDP deflator inflation
    b) stating that it is a misleading indicator of inflation,
    c) stating that we should deflate all GDP, but keep nominal petrol prices in there.

    But the GDP deflator is not inflation (, as a result calling it a misleading indicator only comes from the fact that you have misdefined it.

    Also, not adjusting for petrol price changes implies that we “double count” any change in petrol prices – and as a result our volume measure is wrong.

    “The conspiracy claim sis the refuge of the lazy and ill informed”

    I agree that my claim is lazy (as I could figure out a more suitable way of stating that I thought you were misinforming people), however it is not ill informed.

    Ultimately, I agree with you that people have to be careful when they look at information – to make sure that what they take out of it is actually a logical consequence. However, I am not confident that you have actually done that in this case.

  4. anon
    anon says:

    Very good post.

    You were linked as a key source into David Altig’s fine and credible piece on this at Macroblog.

    Disinformation is no service to those who are trying to understand economics – you’ve done a good job correcting the record here.

    I was the persistent anon on the Big Picture posts.

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