Check Out What GDP Growth Would Look Like If The Government Were Using The Right Inflation Numbers

Harry Potter spell

The headline GDP numbers the government releases every quarter are “real,” meaning that they are adjusted for inflation.

The most recent real GDP number, for Q1, was weak: It was only 1.84% (annualized). If this were an ordinary recovery following a deep recession, the economy would likely be growing 5%-7%. This is why the recovery doesn’t feel like a recovery.

But even that 1.84% GDP number doesn’t tell the whole story.

The way the government calculates real GDP is to start with nominal GDP–the actual change in the output of the economy as measured by adding up all the actual sales prices (“nominal”)–and then “deflating” this number by subtracting an estimated inflation rate. Thus, the government backs into the real GDP growth number, starting with nominal prices and then adjusting for inflation.

Well, the “GDP deflater” the government is using right now–the estimated rate of inflation–is only 1.9%. As anyone who has been to a supermarket or gas station recently can attest, this assumption is preposterously low. But the effect on “GDP growth” of using a very low inflation estimate is helpful, in that it makes real GDP growth look bigger.

So what would Q1 GDP have looked like if the government had used the government’s own estimate of inflation for Q1 (5.7%), instead of 1.9%?

Q1 GDP would have been -1.82%.

The Consumer Metrics Institute (via John Mauldin) explains:

The importance of the price deflater used by the BEA cannot be overstated. In calculating the “real” GDP the BEA continued to use an overall 1.9% annualized inflation rate, which is substantially lower than the inflation rates being reported by any of the BEA’s sister agencies. The mathematical implications of the deflater are simple: a lower deflater creates a higher “real” GDP reading. If April’s CPI-U (as reported by the Bureau of labour Statistics) of 3.2% year-over-year inflation is used as the deflater, the reported 1.84% annualized growth rate shrinks to a 0.56% annualized rate, and the “real final sales of domestic products” is actually contracting at a 0.63% rate. If instead of the year-over-year CPI-U we were to use the annualized CPI-U from just the first quarter (5.7%), the “real” GDP would be shrinking at a 1.82% annualized rate, and the “real final sales of domestic products” would be contracting at a recession-like 3.01%.