The truth about GDP, and why we’re not in a recession

It turns out Britain didn’t experience a double-dip recession last year after all. But only because of the tricky way the government calculates GDP, says Merryn Somerset Webb.

What's the difference between real GDP and nominal GDP? Sounds like a trick question doesn't it? After all, the answer is obvious: real GDP is simply nominal GDP adjusted for inflation.

But the thing is that, while that is entirely true, the answer isn't as obvious as you think. That's because the deflator' or the number used to adjust nominal to real isn't any of the ones you might think of as representing inflation.

It isn't the CPI (the one we are now supposed to think of as representing inflation) and it isn't the RPI (the one we used to be supposed to think of as representing inflation). Instead it is, as Pete Comley points out in his new book, Inflation Tax, a number that is "broader in its scope as it includes the price of government services and to a lesser extent that of investment goods and imports/exports."

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So how is it calculated? That's hard to tell. You can look at what the final number is here, and you can note with amazement that it is remarkably low. The GDP deflator has been consistently lower than the RPI since 2007 (an average of 1.3 percentage points) and in the last three years it has averaged 2.2 points lower than RPI something that makes real GDP look much higher than it would if you were just to use straight RPI. But what you can't do is see exactly how it is calculated.

Pete has done a bit of digging on this. He finds that "the UK government does not publish formally how they take into account inflation for GDP", but that the recent discrepancy appears to be largely down to how the government takes inflation into account on its own expenditure. Here they appear to use what is known as hedonic accounting' where they take quality or perceived quality into account when figuring out if something is going up in price. So "estimates from volume measures such as the number of operations, pupil numbers and the like". Hmm.

So let's look at the most recent revisions to our GDP numbers the ones that effectively erased the double dip.

It turns out that the "gross domestic product implied deflator at market prices for Q1 2013 is 2% above the same quarter of 2012." See p15 here. That is rather lower than the average for the RPI (now 3.1%) or indeed for the CPI (now 2.7%).

Maybe it doesn't matter. Maybe it makes perfect sense for the deflator to be so much lower than CPI and RPI (although it is worth noting that for 50 years until 2006 the RPI and the deflator were much of a muchness).

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.