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Lesson M02.L02: Measuring Inflation: CPI vs GDP Deflator

Module: Measuring the Price Level and Inflation; Savings and Wealth Level: intro Duration: 30 minutes Learning Objective: Calculate inflation rates from price index data; compare the CPI and GDP deflator; interpret Australian inflation data from 2020–2024. Provenance: OpenStax Macro 3e | Khan Academy Macro

Explanation

Inflation is the percentage increase in the overall price level from one period to the next. The formula is:

Inflation rate = (Price Index_current − Price Index_previous) / Price Index_previous × 100

Two measures are commonly used:

1. CPI (Consumer Price Index): - Tracks a fixed basket of consumer goods. - Published quarterly by the ABS (cat. 6401.0). - Also published monthly as a "monthly CPI indicator" since 2022. - Headline CPI includes all items; Trimmed Mean CPI (the RBA's preferred measure) strips out the most volatile items to show underlying inflation.

2. GDP Deflator: - Covers all goods and services included in GDP — not just consumer goods. - Includes investment, government, and export goods; excludes imports. - Uses a variable (chain-weighted) basket, so it automatically adjusts for spending pattern changes. - Published alongside national accounts data.

Key differences:

Feature CPI GDP Deflator
Coverage Consumer goods only All domestic production
Basket Fixed (updated periodically) Variable/chain-weighted
Import prices Included Excluded
Frequency (AUS) Quarterly (monthly indicator) Quarterly

Australian inflation 2020–2024 (approximate headline CPI, annual): - 2020: +0.9% (COVID demand collapse) - 2021: +3.5% (supply-chain disruptions begin) - 2022: +7.8% (peak; energy, food, rents surge) - 2023: +4.1% (easing but still above RBA target) - 2024: ~3.2% (continued gradual disinflation)

The RBA responded to the 2022 surge by raising the cash rate from 0.10% to 4.35% between May 2022 and November 2023.

Worked Example

Using Australian data (approximate):

Year CPI GDP Deflator
2021 104.2 106.0
2022 112.3 119.5

CPI inflation 2021→2022: (112.3 − 104.2) / 104.2 × 100 = 7.8%

GDP Deflator inflation 2021→2022: (119.5 − 106.0) / 106.0 × 100 = 12.7%

Why is the GDP deflator higher? In 2022 Australian export prices surged (iron ore, coal, LNG). Export prices are included in the GDP deflator (they are domestically produced) but not in the CPI (Australian consumers don't buy their own exports). The deflator captured the massive commodity price windfall; the CPI focused on what households pay at the checkout.

Common Misconception

Misconception: The CPI and GDP deflator always move together and can be used interchangeably.

Correction: They measure different things and can diverge significantly. The GDP deflator includes export prices and excludes import prices; the CPI does the opposite. In commodity-exporting economies like Australia, the two can diverge sharply when commodity prices spike (as in 2022). The RBA specifically targets CPI inflation, not the deflator.

Practice Prompts

  1. CPI was 105.0 in Q1 2023 and 107.1 in Q1 2024. What is the annual inflation rate? → Answer: (107.1 − 105.0) / 105.0 × 100 = 2.0% — within the RBA's 2–3% target band.

  2. Why might the GDP deflator be higher than the CPI during an Australian commodity export boom? → Answer: Commodity export prices (iron ore, coal, LNG) are included in the GDP deflator (domestically produced goods) but excluded from the CPI (Australian households don't buy those exports directly). A surge in export prices raises the deflator without affecting the CPI.

  3. The RBA monitors "trimmed mean" CPI rather than headline CPI. Why? → Answer: Trimmed mean removes the most extreme price movements (the top and bottom 15% of items by price change) to reveal underlying inflation, filtering out volatile items like fresh fruit or petrol that can spike temporarily without indicating persistent inflation.

Further Resources