The Differences in the GDP Deflator & CPI
The GDP deflator and the consumer price index are both measures of the change of prices — i.e. inflation. Both the GDP deflator and the consumer price index have been shown to generate very similar rates of inflation when compared side-by-side. However, both indicators differ in the way they are measured, and as a result offer both advantages and disadvantages.
The GDP deflator is generated by the Bureau of Economic Analysis every three months. It is essentially a ratio between nominal gross domestic product and real gross domestic product. The nominal GDP reflects the actual prices of goods and services, whereas the real GDP adjusts prices for inflation. What results is an indicator of an economy's price level, which may be tracked over time. In addition, the ratio may be used to convert any price or index from nominal to real terms.
The Consumer Price Index, or CPI, is constructed by the Bureau of Labor Statistics and published monthly. It is an index of prices of the goods and services that are typically purchased by consumers. It is calculated using a basket of goods, which are weighted, along with their respective prices. This basket is compiled from the Consumer Expenditure Survey. There are two types of CPI: The CPI-U uses a basket of goods typical of consumers who spend money in urban areas, whereas the CPI-W uses a basket typical of consumers who earn money in urban areas. Thus, it differentiates those who both live and work in cities from those who work in cities but don't live there.
The GDP deflator measures the price changes in all aspect of the economy, opposed to the CPI, which only analyzes consumer expenditure. For this reason, the GDP deflator tends to be favored and used primarily by economists. In addition to consumer expenditure, GDP also includes investment, government expenditure and net exports. All of these components may change in price for different reasons. Furthermore, the consumer price index only focuses on urban consumers, while the GDP takes into account all consumers, both urban and rural.
The CPI has an advantage in that it is reported more often than the GDP deflator and is therefore deemed to be more timely. Furthermore, the consumer price index is more relevant to the average consumer, as it dispenses with the components of GDP such as investment, net exports and government expenditure. Individuals and families have a better use for the CPI over the GDP deflator as it focuses more on the aspects of consumer expenditure and the price changes associated with it.