What is the Difference Between the CPI, GDP deflator, and PCE deflator?

Economists study changes in the Economy. One tool used is price indexes. A price index is a measure of how prices change over a period of time: it is a way to measure inflation and here are a couple of important price indexes. In this article, we will go through them.

First of all, let’s summarize what the inflation rate is: the inflation rate is the change in prices from one year to the next.

If we want to be a little more detailed in this assessment, we need a basket of goods and services that is representative of all the country’s output. It can be seen from the producer’s perspective and it is called the PPI (Producer Price Index) or the consumer index: this is called the CPI (Consumer Price Index).

From the Producer’s perspective, the PPI Index looks at the cost of intermediate goods used to produce the final goods and also the prices of the final goods.

Consumer Price Index or CPI, on the other hand, reflects the cost of living of a typical consumer, and each country has its “typical consumer”.

There are three variations here:

CPI using the Laspeyres Index = (P1*Q0)/(P0*Q0) * 100

CPI using the Paasche Index = (P1*Q1)/(P0*Q1) * 100

CPI using the Fisher Index = Sqrt (CPI Laspeyres / CPI Paasche)

So the CPI essentially looks at things consumers typically buy.

Then we have the RPI (Retail Price Index), which looks at CPI and other things like housing prices, and costs: rents, mortgages, and the RPI-X which is the same as RPI but excludes mortgage repayments.

PCE is the Personal Consumption Expenditure Index. It shows how much households are spending and on what they are spending on including services such as education. While the CPI uses a fixed basket of goods, the PCE can entail substitute goods that consumers start using if their income changes.

CPI vs GDP Deflator

In the last article we talked about how to calculate the GDP deflator. Here, lets focus on the main differences between the CPI and the GDP deflator.

The CPI taked a fixed basket of approximately 210 goods that a typical family buys, and measures its price changes.

The GDP deflator doesn’t have a fixed basket of goods. It just looks at all goods included in GDP and by dividing the Nominal GDP by the deflator, we get the Real GDP as we can see the increase in prices in relationship to the base year.