GDP deflator

Once you have both a nominal GDP and a real GDP, you can ask a clever question: how much of the gap between them is just rising prices? The GDP deflator is the answer. It is a single number that captures how much overall prices in the whole economy have changed since a chosen base year. Think of it as the price tag of the entire economy, boiled down to one figure.

The GDP deflator is defined as nominal GDP divided by real GDP, then multiplied by 100. By construction it equals 100 in the base year. Suppose nominal GDP this year is 132 and real GDP, valued at base-year prices, is 110. The deflator is 132 divided by 110 times 100, which equals 120. That tells you prices across the economy are 20 percent higher than in the base year. The percentage change in the deflator from one year to the next is one common measure of inflation. Unlike a consumer price index, which tracks a fixed basket of things households buy, the deflator covers everything counted in GDP, including machinery, exports and government services, and its basket changes as the economy changes.

The deflator matters because it is the bridge between nominal and real GDP, and because it gives a broad, economy-wide reading of inflation. Economists watch both the GDP deflator and the consumer price index; they usually move together but can diverge, for example when import prices jump (which can pull the consumer index up while leaving the domestic deflator quieter). Knowing the difference keeps you from treating any single inflation number as the whole truth.