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.
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.