How to Calculate the GDP Deflator

How it differs from CPI, and when that matters

Both track a price level, but over different baskets, and questions turn on the difference.

The GDP deflator covers everything produced domestically, including business investment and government purchases, and it excludes imports because imports are not domestic production. CPI covers what a typical urban household buys, which includes imported goods and excludes machinery and public spending.

So a jump in the price of imported oil lands in CPI straight away, while the deflator barely registers it. A jump in the price of domestically built machinery does the reverse.

The other difference is the basket itself. The deflator compares this year's output at this year's prices against the same output at base-year prices, so its basket updates every year. CPI holds a fixed basket, which means it misses households substituting away from whatever got expensive and so tends to overstate inflation a little.

Reading the number

The deflator is an index, not a percentage, and the base year is always 100. A deflator of 116.7 means prices across the whole of output are 16.7% higher than in the base year. It does not mean inflation was 16.7% this year.

To get inflation between two years, take the percentage change in the deflator: from 117 to 120.51 is (120.51 − 117) ÷ 117 = 3%. Reporting the level as though it were a rate is the usual error here, and it is easy to catch, because an economy with 16.7% annual inflation would be in obvious trouble while an index of 116.7 is entirely ordinary a decade or so after the base year.

A deflator below 100 means prices are lower than in the base year, which puts the base year in the future relative to the data or describes genuine deflation over the period.