In previous articles on formulas for nominal and real GDP and deriving inflation rates from GDP deflators, we’ve touched on the concept of the GDP deflators. I want to briefly focus on the concept here.
GDP deflators show you whether GDP growth comes from inflation or deflation compared to an actual change in output (goods/services created). It does so by comparing nominal and real GDPs from the same base year.
(to review: nominal GDP is the raw number found by a simple P*Q calculation, while real GDP adjusts for inflation)
GDP deflators thus start at 100 and climb from there, with 110 representing 10% price inflation, 150 equaling 50%, and so on.
The formula for GDP deflators is simply (nominal GDP/real GDP)*100. Keep in mind that all the GDP numbers used, whether nominal or real, should reference the same year (say, nominal & real GDP in 2024). The deflator will represent the price change from the base year of the real GDP number. More directly: the GDP deflator reflects price changes from the base year of he real GDP number, thus showing how much prices has increased since that time. So, calculating the GDP deflator using nominal and real GDP from 2024, with real GDP using 2020 as a base year, gives us the price shifts since 2020.
This may sound complex, but just imagine that the real GDP base year is our starting point, and the end point is the year that we’re looking at real and nominal GDP in. If real GDP is calculated starting from 1932, then 1932 is the starting year. If we’re looking at nominal GDP and real GDP numbers in 2016, then that’s our end point, so our calculations will give us the inflation rate from 1932 to 2016.
Here are some more concrete examples:
- Nominal GDP in 2024 = $140,000
- Real GDP in 2024 with 2020 as a base year = $115,000
- GDP deflator = (140/115)*100 = 121.7
- Thus, the GDP deflator for this time period is 121.7
Another one:
- Nominal GDP in 2018: $1.3t
- Real GDP in 2018 with 2017 as a base year: $1.28t
- Thus, the GDP deflator for this time period is (1.3t/1.28t)*100 = 101.56
From these two cases, we can conclude that price inflation was respectively 21.7% over a 4-year period and 1.56% over a 1-year period.
