Consumer Price Index (CPI) vs GDP Deflator

What each index covers

The CPI tracks the price of a fixed market basket of goods and services that a typical household buys, so it is built to measure the cost of living. The GDP deflator tracks the prices of everything counted in GDP, which means consumption plus investment goods, government purchases and exports, with imports netted out. That difference in coverage cuts both ways. Capital equipment bought by firms and goods bought by the government show up in the deflator but not in the CPI, while imported consumer goods show up in the CPI but are stripped out of the deflator, because GDP counts only domestic production. Both indexes equal 100 in the base year, since in the base year the basket costs what it cost and nominal GDP equals real GDP, and both are turned into an inflation rate the same way: take the change in the index, divide by the earlier index, and multiply by 100.

Fixed basket versus changing basket

The CPI holds quantities fixed at base-year levels and reprices that same basket each period, which makes it a fixed-basket, or Laspeyres, index, and although the official statistic does refresh its weights periodically, AP and IB treat it as fixed. The GDP deflator uses current-period quantities instead, because it is nominal GDP divided by real GDP and nominal GDP already reflects what the economy actually produced this period, which makes it a current-weighted, or Paasche, index. The consequence is a bias in each direction. Because the CPI basket does not update when consumers substitute away from goods whose prices rose, it tends to overstate the true increase in the cost of living, a problem called substitution bias. The deflator does not share that upward bias, since substitution shows up in its weights automatically, but a current-weighted index tends to err the other way and understate the rise in living costs, and any movement in the deflator mixes price changes together with changes in the composition of output.

Why the two can tell different stories

Because they cover different goods, the CPI and the deflator do not have to move together, and the gap between them is often the exam question. A jump in the price of imported oil raises the CPI directly, since households pay for imported fuel, but imported goods are not domestic output, so the deflator moves only to the extent domestic producers pass higher fuel costs into the prices of the goods they make at home. A jump in the price of domestically produced machinery does the reverse: it lifts the deflator while leaving the CPI untouched, because households do not buy machine tools. The other frequent slip is reaching for the wrong index. Real GDP is found by dividing nominal GDP by the GDP deflator and multiplying by 100, never by the CPI, while cost-of-living adjustments and real wage calculations are CPI jobs. You can work through both at /calculate/gdp-deflator and /calculate/inflation-rate.

Frequently asked questions