### Maybe an economist can explain this

## Thursday, May 29, 2008

In trying to understand how we continue to get such freakishly low readings in the price indexes that come out with the reports on economic growth, this data was stumbled upon:

Can anyone explain to me how rising import prices cause the GDP price index to go down this much? I understand the basic principle of how imports/exports are accounted for in the GDP number, but these percent contributions look exceedingly large.

## 4 comments:

The commodities bubble is popping again....what is this like the sixth time this year???

The reason is that dollar devalued, even increasing total export amount. on other side, foreign countries account inflation by average 7% Vs our official 2.5 or 3%. We fool ourself all the time.

"Can anyone explain to me how rising import prices cause the GDP price index to go down this much?"

I think you are comparing apples and oranges here. Import amounts are subtracted from the total amount in calculating the GDP (GDP = consumption + gross investment + government spending + exports − imports). Thus a decrease in imports, everything else being equal, would increase GDP.

Now you may wonder why imports decreased with increasing prices, and this goes to how real GDP is calculated. It is not calculated, as you might think, by calculating nominal GDP and dividing by an inflation index; instead, the BEA calculates both real GDP and nominal GDP, and the difference between the two (in chained dollars) is used to calculate the "implied price deflator" (or IPD).

So how is real GDP calculated? For the current period, you use the nominal GDP (total dollars spent). Then you re-calculate the prior period's GDP based on current prices (e.g., when calculating imports of oil in the prior period, you would take barrels imported in the prior period times the current price per barrel), and then determine real GDP growth based on the proportion of the two. This should remove the effects of price increases on "real GDP", which is the goal. Then - and this part I am sketchy on - I think you multiply this ratio by the prior real GDP to come up with the current real GDP. Then you take the current GDP (nominal) and divide by the real GDP to get the implicit price deflator.

Thus even if the cost of imports is increasing, the real GDP can indicate a decrease in imports (assuming the number of goods imported decreases). The price increase, however, should bubble through to the implicit price deflator (since the ratio of nominal to real GDP should increase in that period).

Now whether this gives an accurate picture of "real GDP" and what we would think of as "inflation", is a whole other question . . . . Also you have to account for "hedonic adjustments" made to the price of goods, the BEA has a long paper on it at http://www.bea.gov/papers/pdf/hedonicGDP.pdf which I have not read.

Thanks for the explanation.

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