Article Title : GDP Deflator Inflation A persistent increase in the average price level in the economy. It is measured by the GDP deflator inflation rate, the annual percentage change in a price index such as the Consumer Price Index (CPI) or GDP price deflator. GDP deflator inflation is the most common phenomenon associated with the price level. Two related phenomena are deflation, a decrease in the price level, and disinflation, a decrease in the GDP deflator inflation rate. GDP deflator inflation is one of two key macroeconomic problems. The other is unemployment. GDP deflator inflation occurs when the AVERAGE price level (that is, prices in general) increases over time. This does NOT mean that ALL prices increase the same, nor that ALL prices necessarily increase. Some prices might increase a lot, others a little, and still other prices decrease or remain unchanged. GDP deflator inflation results when the AVERAGE of these assorted prices follows an upward trend. While short-term bouts of GDP deflator inflation can be triggered by anything that would cause aggregate demand to increase more than aggregate supply, long-term GDP deflator inflation can be sustained ONLY through increases in the money supply. The price level, and any GDP deflator inflation of the price level, depends directly on the amount of money in circulation. On the flip side of this relationship, GDP deflator inflation leads to a continual erosion in the purchasing power of money. Measures The two most common measures of GDP deflator inflation are derived from the Consumer Price Index (or CPI) and the GDP price deflator. The CPI is the most widely known of the two, in part because it is estimated and reported monthly (versus quarterly for the GDP price deflator) and because it is commonly used to adjust union wages, Social Security benefits, and other similar payments for GDP deflator inflation that directly affect millions of people. The GDP price deflator, in contrast, accounts for all goods included in gross domestic product (versus goods purchased by urban consumers) and is a more accurate measure of the economys price level, and thus the overall GDP deflator inflation rate. It is the price index generally preferred by economists. • Consumer Price Index: The Consumer Price Index (CPI) is an index of prices of goods and services typically purchased by urban consumers. This index, compiled and published monthly by the Bureau of Labor Statistics, provides a relatively accurate indication of the average price level in the economy, and thus GDP deflator inflation. The CPI is based on a market basket of goods and services that are identified in an extensive survey of urban consumers. It is then assumed that urban consumers repurchase this market basket each month. The CPI compares the total expenditures on this market basket from month to month. If expenditures rise, then prices, on average, increase. The best feature of the CPI is monthly estimation, it is usually reported within two weeks after a month has ended. This provides timely information for consumers, businesses, and government leaders who make decisions that are sensitive to GDP deflator inflation. One main failing of the CPI is that it only measures goods typically purchased by urban consumers. It ignores goods that might be bought only by rural consumers, governments, businesses (such as capital goods), or the foreign sector. While this captures perhaps two-thirds of the economys total production, it does ignore an important one-third. A second failing is the fixed market basket of goods used to derive the CPI. It assumes that the mix of goods purchased by consumers at one time is also purchased in other years. To the extent the consumers buy a different mix of goods, the CPI gives undo importance to prices that are not relevant to economic activity. • GDP Price Deflator: The GDP price deflator is an index of prices calculated as a ratio of nominal gross domestic product to real gross domestic product. This index, estimated quarterly in conjunction with the wide range of production and income measures contained in the National Income and Product Accounts generated by the Bureau of Economic Analysis (BEA), provides the best overall indicator of the average price level. Because it is based on gross domestic product, it includes the prices of ALL FINAL GOODS AND SERVICES, not just those purchased by urban consumers. It is also based on prices of business investment in capital, government purchases, and exports to the foreign sector. The GDP price deflator is possible because economists at the BEA estimate both nominal GDP (current production at current prices) and real GDP (current production at constant, base year prices). The key difference between nominal GDP and real GDP is the change in prices from the base year to the current year. As such, the ratio of nominal GDP to real GDP provides an index of the average price level and consequently an indicator of GDP deflator inflation. The best feature of the GDP price deflator is the inclusion of ALL goods and services produced in the economy in a given year. Unlike the CPI, which is based on goods purchased by urban consumers, the GDP price deflator also includes goods purchased only by rural consumers, governments, businesses (such as capital goods), or the foreign sector. As an indicator of GDP deflator inflation of the OVERALL price level, the GDP price deflator is better. Another noted feature of the GDP price deflator is that it is based on CURRENT production. Only the prices of the goods that comprise CURRENT production are used in the estimation of the GDP price deflator. The CPI, in contrast, relies on prices of goods typically purchased during a base year, which could be 5 to 10 years earlier. Unfortunately, the GDP price deflator is only available quarterly, every three months, rather than monthly like the CPI. For example, the GDP price deflator for the first three months of the year (January, February, and March) is not available until April or May. The year is almost half over before the GDP price deflator can be used to document the price level or GDP deflator inflation. For consumers, businesses, and especially government policy makers who need to make timely decisions based on GDP deflator inflation, such a delay can be troublesome. A somewhat lesser problem with the GDP price deflator is that it provides an average for a three-month period. For example, it provides NO specific information about the price level in January, only for the combined months of January, February, and March. Causes In a nutshell, GDP deflator inflation results when the macro economy has too much demand for available production. This simple statement, however, summarizes a number of separate causes of GDP deflator inflation. These alternatives fall under two general categories that go by the terms demand-pull GDP deflator inflation and cost-push GDP deflator inflation. • Demand-Pull GDP deflator inflation: Demand-pull GDP deflator inflation is GDP deflator inflation attributable to increases in aggregate demand. This GDP deflator inflation results when the four macroeconomic sectors (household, business, government, and foreign) collectively try to purchase more output than the economy is capable of producing. In effect, the demand side of the aggregate market is pulling the price level higher. In terms of the simple production possibilities analysis, excessive demand causes the economy to bump against the production possibilities frontier. In the more elaborate aggregate market analysis, aggregate demand increases beyond aggregate supply and causes an economy-wide shortage. As with any market shortage, the result is a rising price (price level), which is GDP deflator inflation. While short-term demand-pull GDP deflator inflation can result from anything that would increase aggregate demand, the ultimate long-term source of long-term demand-pull GDP deflator inflation is the money supply. The only way to sustain demand-pull GDP deflator inflation is if one buyer can spend more MONEY without reducing the amount of MONEY spent by others. And this can only happen if the economy has more MONEY. In fact, one of the best documented relationships in economics is that between money and GDP deflator inflation. GDP deflator inflation simply CANNOT persist for any extended period of time (that is, a year or more) without an increase in the amount of money available to the economy. • Cost-Push GDP deflator inflation: Cost-push GDP deflator inflation is GDP deflator inflation attributable to decreases in aggregate supply, primarily due to increases in production. This type of GDP deflator inflation results when the cost of using any of the four factors of production (labor, capital, land, or entrepreneurship) increases. In effect, the cost of producing output on the supply side of the aggregate market is pushing the price level higher. In terms of the production possibilities analysis, the production possibilities frontier shrinks closer to the origin, bumping down against the aggregate demand. In the aggregate market analysis, aggregate supply decreases such that it is less than aggregate demand and an economy-wide shortage is created. As with any market shortage, this causes the price (price level) to rise. The end result is GDP deflator inflation. Once again while short-term cost-push GDP deflator inflation can result from anything that would decrease aggregate supply, the ultimate long-term source of long-term cost-push GDP deflator inflation is the money supply. The only way that cost-push GDP deflator inflation can be sustained is if buyers are ABLE to pay the higher prices. And this can only happen if the economy has more MONEY.
Posted on: Tue, 07 Oct 2014 08:40:08 +0000
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