Using the GDP Deflator to Compare Long-Term Asset Prices
Summary
The document asks how to adjust long historical series of US stock and gold prices for changes in the dollar's purchasing power. The questioner worries that CPI may not capture the desired concept of inflation, and notes that comparisons of CPI, wages, and the implicit GDP deflator appeared similar in their own review. A response recommends the GDP deflator as a broad measure because it reflects prices across the economy rather than only a consumer basket.
The deflator is described as the ratio of nominal GDP to real GDP and is published by statistical agencies. This gives researchers an available series for converting nominal observations into a measure adjusted for economy-wide price changes. The response does not provide a worked adjustment of the asset-price series or compare the statistical properties of candidate deflators. The deflator also measures a different scope from CPI, so the appropriate choice depends on what purchasing-power concept an analysis intends to represent; it does not remove every possible source of long-run price-series distortion.
Key ideas
- The GDP deflator provides an inflation measure covering the broader economy rather than only consumer goods.
- It is defined through the relationship between nominal and real GDP.
- Published deflator data can be used to adjust nominal asset-price histories.
- The document does not demonstrate that the GDP deflator is universally superior to CPI.
Tags
Full text
# How to deflate USD inflation?
# How to deflate USD inflation?
On the picture below prices of SP500 and Gold (rescaled) for last 90 years.
There are at least 3 types of distortions caused by inflation:
- Slow upward trend.
- Sudden jumps caused by radical changes in policy, like changing gold standard in 1933-1934.
- Smaller jumps caused by fed rate changes.
I wonder if there are ways to somehow remove those distortions and have a better and more stable measure of the price? Instead of raw USD that jumps around chaotically.
The biggest problem is that it's impossible to compare prices on long intervals. It's kinda ok to ignore inflation on interval of 1-3 years, but not 10 or 20 years.
The CPI can't be used. As CPI as a conventional measure of inflation measures something totally different. It measures price of basket. But because of the technological advance - the price of basket constantly going down. But as soon as USD falling even faster - it overtakes falling basket and we perceive the situation as if the price of basket is growing.
So, the real inflation is higher than CPI and it also has small fluctuations caused by FED rate and radical policy changes. I wonder if there are some better approaches for adjusting inflation than CPI.
Maybe something like 10 Year Treasury Rate could be used to infer the real inflation or something like that?
UPDATE:
I compared different measures of inflation:
- CPI
- Minimum wage
- Median wage
- Implicit GDP deflator
Seems like all of them are quite similar.
## Answer by Martin Vesely (score 1)
https://quant.stackexchange.com/a/52890
You can measure inflation by so-called GDP deflator. The inflation for year $y$ is given by formula
$$ \pi_y = \frac{\text{GDP}_{nominal}}{\text{GDP}_{real}}. $$
The advantage of deflator in comparison with CPI is the fact that it measures inflation accross economy and not only for basket of consumers products.
The deflator is also published by statistical offices, so you do not have to calculate on your own.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.