What is the GDP deflator?

What is the GDP deflator?

GDP deflator is a price index that measures the gross domestic product by adjusting the impact of changes in prices of goods and services to the true value of goods and services produced locally in the economy. As the name suggests, it serves a specific purpose of giving the real GDP from the nominal GDP by deflating the price effect.

For example, a price deflator of 50 means that the current year price is half the base-year price — price deflation. It is the most general measure of the overall price levels. It takes into account changes in government consumption, capital formation , international trade and household consumption.

Why is it a good measure of GDP?

It is considered to be a relatively better measure of GDP because it takes into consideration a broader basket of goods and services, unlike the Consumer Price Index ( CPI), which essentially considers consumer goods. Change in prices can give an impression that the GDP has grown or declined, without any real change in the quantity of goods and services produced. The deflator gives the real picture. However, the problem with the measure is that, in most countries, it gives annualised estimates, thus the time lag in deriving the estimates might bring in some distortions. GDP deflators are used to segregate price from quantity and not as a measure of inflation.

Why is it more preferable over other measures while measuring national incomes globally?

The definition of a household, the basket of goods chosen and the geographic and income group coverage of consumer prices can vary across countries, if consumer price indices are alone used, thus making comparisons ambiguous. Another problem is that the weights are derived from household expenditure surveys, which are conducted infrequently in developing countries and for the same reasons would make comparisons invalid.

How is it used in India?

India uses a combination of Wholesale Price Index ( WPI) and Consumer Price Index (WPI) as deflator on a quarterly basis with a time lag of two months. The usage is dependent on the particular estimate we are trying to deflate. There will be different deflators for private consumption and government consumption . There is a difference in the value of quarterly and year-end deflators due to price variations over a period of time. At the year-end , we have an overall measure of WPI/CPI, which is used appropriately. This is why year-end estimates of GDP are more reliable than quarterly estimates.