In my previous post, I discussed how the 2008Q2 advance GDP estimate would be revised, and the possibility that the final figure (after annual revisions) could enter in below zero. One reason that might occur is because the GDP deflator could be revised upward. Suspicion that this might occur is heightened by the seemingly implausible 1.1% SAAR inflation rate recorded for the GDP deflator (see the comments to this post, as well as Felix Salmon, and (0)). One question I want to address is whether this figure is actually so implausible.

I think the answer is no. And the reason is the distinction between the GDP deflator, which measures the price level for goods and services produced, and the gross domestic purchases deflator, which measures prices of goods and services purchased. Specifically, the two price indices pertain to these two concepts, respectively:

GDP = C + I + G + EX - IM

Gross domestic purchases = C + I + G

Where C is consumption, I is investment, G is government spending on goods and services, EX is exports and IM is imports.

To illustrate the difference between the two concepts concretely, consider the following. From the perspective of the household, we as individuals are certainly more familiar with the goods that we've spent funds on, as opposed to those consumer goods produced by the US economy, some of which are exported. The prices of those two bundles can obviously differ.

It turns out that over long spans of time, the price deflator for production and expenditures match trends (are cointegrated, in log-levels), but over short periods, they can diverge. And indeed, inflation rates have diverged substantially over the past few quarters.

Figure 1 highlights how the inflation rate for what we buy has accelerated over rates for what we make. Is this surprising? No, I think it's a natural implication of the United States running a massive current account deficit that the rest of the world no longer wishes to finance on the (favorable) terms it previously received.