Will the "Real" GDP Please Stand Up? (The Deflator Makes Big a Difference)
Note from dshort: With today's release of the Personal Consumption Expenditure (PCE) price index, I've spent some time updating my ongoing analysis of the government's calculation of Real GDP for Q1 released on Friday.
How do you get from Nominal GDP to Real GDP? You subtract inflation. The Bureau of Economic Analysis (BEA) uses its own GDP deflator for this purpose, which is somewhat different from the BEA's deflator for Personal Consumption Expenditures and quite a bit different from the better-known Bureau of Labor Statistics' inflation gauge, the Consumer Price Index.
The charts below show quarterly Real GDP since 1960 with the official and three variant adjustment techniques. The first chart is the official series as calculated by the BEA with the GDP deflator. The second starts with nominal GDP and adjusts using the PCE Deflator, which is also a product of the BEA. The third adjusts nominal GDP with the BLS (Bureau of Labor Statistics) Consumer Price Index for Urban Consumers (CPI-U, or as I prefer, just CPI). The forth chart, prompted by several requests, adjusts nominal GDP using the Alternate CPI published by economist John Williams at shadowstats.com
I've calculated the latest GDP in all versions to two decimal places to help highlight the differences.
The Lower the Deflator, the Higher the GDP
I have a note at the bottom showing the real GDP calculation method. Suffice to say that the higher the increase in compounded annual percentage change in the deflator, the lower the real GDP. Conversely the lower the increase (or if there is a decrease), the higher the real GDP. With this in mind, consider: The BEA puts the latest compounded annual percentage change in the GDP deflator (i.e., the inflation rate) at 1.5%. That is quite low, which gives us a higher GDP number. If I make the same calculation using the compounded annual percentage change for seasonally adjusted quarterly CPI, I get an inflation rate of 2.5%, a full percent higher.
Suggestion: Click on any of the charts below and use the links at the top of the chart page to toggle between the versions for a closer comparison.
The PCE and GDP deflators are both the work of the Bureau of Economic Analysis, but as a comparison of offical GDP and the PCE-deflated variant illustrate, the rate of inflation can vary siginificantly, depending on which series the BEA is deflating.
The CPI comes from a different government agency, the Bureau of Labor Statistics, and is calculated quite differently. As an inflation measure, it is much better known than the GDP and PCE deflators, and its growth rate has been higher than the two BEA metrics (see this illustration). If we use CPI as the deflator to compute Real GDP, we see a lower mean, a higher volatility, and a Q1 Real GDP of 1.26%. Note: For an apples-to apples comparison, I'm using the seasonally-adjusted quarterly CPI (the CPIAUCSL in the FRED repository) since the PCE and GDP deflators are both seasonally adjusted.)
Last year after my original post of this series, I received several requests for an additional version using the Shadowstats alternate CPI as the deflator.
I find this "alternate Real" GDP to be interesting (in a freakish sort of way), but I personally see no credibility in the hyper-negative GDP it produces. On the contrary, I see this chart as further evidence that the alternate CPI is a misguided concept.
I'll be updating this chart series after the Second Estimate of Q1 GDP is released next month.
Notes:
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