The ‘secret deflator’ used to fiddle the GDP figures

I wrote here a few weeks ago about the oddly opaque manner in which the government figures out what inflation-adjusted GDP growth in the UK is.

It doesn’t use the RPI or the CPI as a representative of inflation – as you might think they would – instead, it uses its own deflator. I have no idea how that is calculated, and I strongly suspect that almost no one else does either.

The key point to note is that until 2010 the RPI and the deflator were much of a muchness. But in the last few years, they have suddenly (and to my mind inexplicably) parted ways.

James Ferguson at MacroStrategy Partners has kindly picked this point up for me and produced this chart:

Real GDP vs NGDP adjusted for RPI

GDP v NGDP

If you assume that the Office for National Statistics’ occult calculations for the deflator are entirely reasonable and correct, the UK has avoided a double dip recession (hooray!).

If, on the other hand, you note that the deflator and the RPI have rarely diverged in the past, and so think that using the RPI to deflate nominal GDP continues to make perfect sense, it turns out that the real economy has been contracting since 2008 (boo!).

That’s not a double dip. It is a depression.

  • marquis

    There seems to have been a few other periods where the two diverged, so probably a bit too early to cry ‘fiddle’. If it persists, maybe. However, GDP deflators have been around for a long time, and I believe are meant to take a broader measure of the prices in the economy than RPI and CPI, which are geared more towards the cost of individuals. So you wouldn’t expect a perfect match.

    But yes, it probably all is another huge conspiracy that will result in gold soaring and house prices will crash. Not.

  • Pete Comley

    As the person who first drew this to Merryn’s attention, here is some more info. My analysis shows that the difference is probably related to the way that government expenditure is deflated, i.e. since 2010 the deflator has been assumed to be near zero.
    Although there appears to be no technical manual published for the GDP deflator, you get some explanation in a recent BoE Inflation Report – see page 21 in: https://www.bankofengland.co.uk/publications/Documents/inflationreport/ir12may2.pdf.
    Basically what this says is that most of government expenditure is compared with volume measures for it and hence the GDP deflator calculated by deduction. These volume measures for government expenditure are calculated from things like the number of hospital admissions, number of kids getting grades A-C at GCSE etc.
    For example, say for sake of argument that all government spending was on secondary education whose key purpose is to get students with grades A-C. If last year this was 60% of students and this year it went up to 63%, the volume measure for GDP would have gone up 5%. If the government spent 5% more on education, then the deflator would be calculated as zero.
    Clearly spending 5% more on education in 2013 is unlikely to suddenly impact on the grades of students in just 2013, who have been in secondary education for many years. It is a much slower process than that. Furthermore the extra spending might be towards creating new facilities that are not even built yet.
    You can see this in the data in that BoE report. During the Blair/Brown years, massive amounts of extra cash were poured into government spending and comparatively little return was seen for them in each year it was spent. This led to quite high deflators on government expenditure.
    The process has now gone into reverse. Spending has been halted (largely) but the “improvements” in volume measures from the investments over the last decade still continue. Therefore since 2010, we’ve had the bizarre situation where the implied deflator has been almost zero for any government expenditure.
    The implications of this are that GDP may be looking a lot higher than it really is.

  • Shaun Richards

    Hi Merryn

    I can help with what has been happening with the GDP implied deflator as I covered some changes made to it back in October of last year on my Notayesmanseconomics blog. If you read the explanation linked to below it will become clear why the implied deflator now longer follows RPI and in fact that the consumer section (where RPI is most relevant) no longer does either.

    https://notayesmanseconomics.wordpress.com/2012/10/25/why-was-the-calculation-of-uk-gdp-changed-lower-recorded-inflation-so-higher-growth/

    For the same reality economic growth in the UK will be recorded as higher than before…

  • Colin Selig-Smith

    Politicians fiddling the numbers to make themselves look better? Say it ain’t so Merryn!

    Course if it’s a depression, Government bonds are very much the place to be.

  • marquis

    Interesting responses guys. Many thanks. I usually think of GDP as a fairly imprecise indicator at best, with all the late revisions etc, and I believe we are all far too obsessed with it. Did anyone hear all the fuss made about it on ‘Wake Up To Money’ this week — ridiculously over the top.

  • Merryn

    Thanks Shaun and thanks Pete.

  • Anonymous

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  • Cilurnum

    An excellent article and why we all need to wake up, smell the flowers and look long and hard at the figures we are fed.

    I simply cannot abide GDP as credible at all since when a government prints and spends it ultimately counts as ‘growth’. It also makes comparisons such as historical debt/GDP ratios completely meaningless.

    • Boris MacDonut

      Of course you can’t abide GDP because it keeps showing us getting richer and richer and richer, while you want to pretend otherwise. GDp must be a very uncomfortabl;e indicator always contradicting your made up doom.

      • Cilurnum

        You haven’t wanted to read the article then? I thought not. GDP is now total nonsense I’m afraid, and no it is not a measure that incomes are rising.

        • Anonymous

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          • Cilurnum

            So what did the above comment have to do with the article or anything that I wrote?

            You post nonsense, and then in true fashion try and claim that the nonsense you wrote is misrepresented to avoid any further discussion. I think we’re at the end of you producing any comment around here that sounds vaguely like sense.

            GDP is nonsense, as this article posits, and as I’ve said before it is in no way a measure of rising incomes and does not show us getting richer in any way. You have nothing to argue against that.

            • Boris MacDonut

              Not sure why you have been so hard on Karim. But I would suggest if you posit that GDP is a nonsense then any claim that debt is too high is a nonsense too, as you doom-mongers always compare it to GDP.

              • Cilurnum

                My reply obviously wasn’t to Karim………. He correctly sees that increasing government spending, and debt, which increases GDP is nuts. If your population is growing on a per capita basis we get worse off, and Boris agrees that the population is increasing because it suited his agenda in another thread of expanding housing and building.

                Ahhh, dear Boris. If GDP is being overinflated in the way this article argues and the debt-to-GDP figures are already bad and several times the size of your economy…..what does that tell you?

                • Boris MacDonut

                  Ahhh dear Cilurnum. That is where you are wrong ,yet again. Income is related to GDP,yes. Income is also only pertinent to adults as it is they who recieve income. While the UK has an increasing population ,the number of adults has not moved much. It has been between 48 and 49 million for around 5 years.
                  Also, I hate to disillusion you, but I never accepted that debt figures are bad. Nor that GDP is overinflated. So you sing from from rigged hymn sheet in church where I am agnostic.

                  • Mikeyman

                    The GDP figure is exaggerated if it includes activities that are funded from taxation or from borrowing. And that is precisely what they do include – at least in the USA and as I understand it also here in the UK.
                    I know that Boris doesn’t agree that there is anything wrong with that, so let me give an analogy:- suppose Joe is a family man with a wife and two sons. He and his wife both work and bring in £1000 per week as income, so you could say that Joe’s family’s GDP is £1000 per week. Suppose he pays £100 per week towards his mortgage. It would be misleading to count that as part of his GDP – it is an expenditure, and not income. If his house goes up in value, that could be counted towards GDP – provided if the value goes down then that is deducted from GDP. Suppose he gives one son £10 per week for walking the dog and the other £10 per week for tending the garden. It would also be misleading to count that as GDP, since it’s merely transferring money between family members. But if son No. 2 manages to grow £100 worth of vegetables, then that £100 counts towards the family’s GDP. Likewise, if son No. 2 digs up a treasure worth £1000, then that goes on the family’s balance sheet and if they sell it, it adds to their GDP for that week. If son No. 1 decides to set up a dog-walking business, then the income he brings to the family counts towards their GDP – but the £10 per week he gets for walking his dad’s dog does not.

                    • Anonymous

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                    • Boris MacDonut

                      #24 Is an odd post. What if the employer pays the £1,000 wage from his own bank borrowings?
                      The £100 paid off the mortgage is income to the bank and is much more than £100 if it is lent back out under the fractional reserve banking system. One persons expenditure is another’s income. The whole point of GDP is a measure of all activity. You seem to want a limited measurment of primary extraction.
                      In the example given the son who previously had a GDP of nil has seen an infinitely huge increase in GDP himself on earning the £10. I think you doom-mongers are mainly tightwads who hate borrowing and enjoy spending even less.

                  • Anonymous

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      • dialucrii

        Boris,

        Do you seriously mean that? I do wonder whether you say some things just to provoke a reaction.

        To suggest that GDP figures are anything other than nonsense in both their meaning and composition is extremely narrow minded and makes it hard to respect you other more useful comments.

        When will the penny drop – no one gets richer by increasing debt and the GDP calculations have been manipulated to include as much spending of borrowed money as possible.

        Do you ever look at the news Boris? And by News I do not mean the mainstream media that present every 0.1% increase in “GDP” as sign of a recovery – In the US the number of people on food stamps has increased by 13% a year from 2008-2012. In Europe the unemployment rate reached a record high in April. Please, if you can, explain to us how more and more people on the wrong side of these statistics are getting “richer and richer and richer”?

        You must live in a very sheltered world indeed.

        • Boris MacDonut

          Individuals are not getting richer, due to inequality. But the whole of society is getting richer, because the rich are getting much,much richer. Any realist knows to look throught the emotion and noise. Wealth and income are higher, we are generally richer.

          • Carrick

            Sorry, I missed how this is a good thing?

          • Anonymous

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  • Ashropshirelad

    Whatever the reason for the discrepancy and a smoothing average might be one reason, the long term trend is clearly downwards.
    Which belies the oft stated claim that mass immigration is good for the economy.
    Immigration continues to rise and GDP continues to fall.
    Payments to the EU continue to rise and GDP continues to fall.
    Marginal tax rates continue to rise and GDP continues to fall.
    Faith in politicians continues to fall in line with the continued decrease in GDP and increases in immigration.
    I wonder why ?

    • Boris MacDonut

      Ashrposhirelad. The trend is downwards because the rise in polulation has been decreasing since 1972.GDp risesa re directly related to population rises. Immigration does help, but we severely restrict it and that halts GDP growth.

  • Karim123

    As other commentors have said, GDP is a useless measure of anything – it is easily manipulated, and “bad” spending (e.g. invading Iraq) somehow pushes up our GDP as if it were a “good” thing. So does hiring more bureaucrats in non-jobs, and so on. Lots of utterly useless spending will push up GDP, but it doesn’t mean we should do it!

    And, of course, immigration pushes up GDP. However, if your population is growing faster than GDP (and it has been for 10 years) then we are actually getting worse off, on a per capita basis.

    As a person, an individual, I am far more interested in standard of living. I would prefer to see a median real income measure discussed in the news, rather than GDP. GDP, even if it were measured in an honest, non-manipulated way, is utterly meaningless to real people.

  • Tony Hart

    How about reducing any increase in GDP by any increase in borrowing? The government borrowed some £33 billion in the 2nd quarter, which is 2% of GDP, which would mean that there was a reduction in true GDP (ie not funded by borrowing) of 1.4%. And that isn’t counting the rest of us (does anyone know whether private borrowing increased or decreased?)

    • Anonymous

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  • Mikeyman

    It seems to me that Government spending, be it of money taken in taxation or of money borrowed, should not be a component of GDP. All Government expenditures – whether on education, health or defence, etc. – are really just overhead on the country and should not be regarded as productive activity for the purpose of calculating GDP. In the private sector they do not count overheads as turnover. Governments on both sides of the Atlantic are guilty of doing this.

    • Anonymous

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    • Cilurnum

      Thats why we have debt/GDP ratios. The ability of GDP to service debt. To have GDP go up with debt it simply insane, but that’s all governments have now. To not do so would make things look very worrying indeed.

  • Mikeyman

    That would indeed be nonsense but you are not accurately reflecting what I said. I think you are confusing the GDP with the money supply. That would indeed be nonsense.

  • Mikeyman

    if anyone wants to see the tricks that governments use to maximise their GDPs and minimise their reported rates of inflation, I recommend Michael Pento’s excellent book “The Coming Bond Market Collapse: How to Survive the Demise of the U.S. Debt Market”. For a comparison of how Joe Schmoe and his government manage their respective finances, I recommend Mitch Feierstein’s book “Planet Ponzi”. They are both available for Kindle. You may need a bit of cheering up after reading them!

  • Merryn

    Another piece on the flawed deflator and GDP. Bit more complicated but well worth reading. https://www.primeeconomics.org/?p=2144