Frequently Asked Questions

how to calculate gdp deflator


How do the effects of dollar depreciation show up in the GDP accounts?

The most obvious effects of dollar depreciation on the GDP accounts are evident in the impacts on net exports, GDP, and prices.

Current-dollar GDP. When the dollar depreciates against major foreign currencies, one generally expects to see current-dollar exports increase, as U.S. produced goods become cheaper abroad. The effect on current-dollar imports is more ambiguous: Depreciation increases the dollar cost of a given volume of imports, but the volume may decline to the extent that domestic goods and services are substituted for imports in response to the increase in the relative cost of purchases from abroad.

Assuming that the export stimulus effect and the volume effect on imports together outweigh the import-cost effect, dollar depreciation would be expected to lead to an improvement in U.S. competiveness, an improvement in net exports, and a corresponding increase in GDP.

The price and quantity effects that move in opposite directions as a result of U.S. dollar depreciation are often difficult to identify separately from movements due to other market forces. For example, dollar depreciation against oil-producing nations’ currencies would result in an increase in the price of imported petroleum and a likely decrease in the quantity of petroleum imported -- the magnitude of the response would be determined by the product’s elasticity (responsiveness to price change). However, other developments in the economy may also affect the demand for petroleum, such as cyclical fluctuations or changes in fuel economy, to a degree that often cannot be readily determined. In addition, the separate effects may be difficult to identify because the foreign supplier may not fully pass through the costs associated with dollar deprecation or the domestic seller of the imported product may absorb some of these costs.

Real GDP. The effect of dollar depreciation on real GDP is less ambiguous than the effect on current-dollar GDP. Assuming that it is possible for domestic production to substitute for imports, dollar depreciation will lead to increases in U.S.-based production as domestically produced goods are substituted for imported goods. This would lead to an increase in real GDP and a decrease in real imports. Dollar depreciation may also lead to an increase in U.S.-based production for export, as foreigners substitute “cheaper” U.S. goods for goods produced in their own countries. This added production would also lead to an increase in real GDP. The ultimate effect, however, of dollar depreciation on GDP depends on many factors, including the extent to which other countries adjust their own currencies in response to dollar depreciation.

Prices. The price index for GDP is not directly affected by dollar depreciation because GDP is a measure of domestic production and does not include the value of imported goods and services. As a result, the price index for GDP can differ substantially from BEA’s price indexes for

personal consumption expenditures (PCE) and for gross domestic purchases. These indexes include both the direct and indirect effects of higher import prices. The PCE price index includes the prices of all goods and services sold to U.S. consumers (including imports, but excluding exports), and the gross domestic purchases price index is derived from the prices of PCE, gross domestic private investment, and government spending. (See the FAQ on the differences between the GDP price index and the gross domestic purchases price index .) These price indexes provide a better measure of domestic sales prices than the GDP price index, which is a measure of domestic production prices.

There are a number of measures in the GDP accounts specifically designed to measure the effect of changes in export and import prices, including “terms of trade,” “command-basis GDP,” and “command-basis gross national product.”

Terms of trade. The terms of trade (shown in NIPA table 1.8.6) is a measure of the relationship between the prices that are received by U.S. producers for exports and the prices that are paid by U.S. purchasers for imports. It is defined as the ratio of the deflator for exports of goods and services to the deflator for imports of goods and services. For example, in the third quarter of 2009, the price index for imports of goods and services increased 8.6 percent (annual rate), while the price index for exports of goods and services increased 4.6 percent. The terms of trade for that quarter declined 3.7 percent. Changes in the terms of trade reflect the interaction of several factors, including movements in exchange rates, changes in the composition of traded goods and services, and changes in producers' profit margins.

Command-basis GDP and gross national product. Also shown in NIPA table 1.8.6 are alternative measures of real GDP and real GNP, called command-basis GDP and command-basis GNP. that reflect gains or losses in real income resulting from trading gains. To calculate command-basis GDP (or GNP), current-dollar GDP (GNP) is deflated by the price index for gross domestic purchases. Thus, the command-basis measures are alternative measures of real GDP and real GNP that reflect the prices of purchased goods and services, while the primary measures of real GDP and real GNP reflect the prices of produced goods and services. For the third quarter of 2009, real GNP grew 2.6 percent, but command-basis GNP only grew 2.0 percent. In other words, because of the decline in the terms of trade in that quarter, the purchasing power of the U.S. economy did not grow as rapidly as its real output. Similarly, the price index for gross domestic purchases grew 1.4 percent in the third quarter of 2009, while the GDP price index increased 0.7 percent. The difference in these indexes indicated that prices paid by U.S. residents were increasing more rapidly, on average, than the prices they received for their production.


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