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

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.”

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).