Friday, April 24, 2009

the implicit deflator of GNP

The implicit deflator of G.N.P. is not a price index in the ordinary sense,and,before attempting to assess its suitability for the purpose of measuring inflation,it may be desirable to explain the way in which it is calculated. The implicit deflator of G.N.P., SAY for any quarter,is obtained by dividing the G.N.P.for the quarter in terms of current prices by the G.N.P.for the quarter in terms of constant prices. For example,Australia,s G.N.P.for the September quarter 1968 was $6446 million in current prices and $6133 million at average 1966-7 prices. Hence the implicit deflator of G.N.P.for this quarter was 1.051 (=6446/6133)on the base 1966-7=1.
It will be clear from this explanation that,while the implicit deflator of G.N.P.is not a genuine price index,it can be interpreted in the same way as a price index.
Specifically,it can be thought of as a price index relating to all goods and services comprising G.N.P., that is to all goods and services produced within Australia.For example, Australia,s implicit deflator for the September quarter 1968(1.051)can be interpreted as indicating that the prices of all goods and services produced within Australia was a little over 5 per cent higher,in this quarter,than the average level for 1966-7.
Since the implicit deflator is,in effect,a price index relating to the goods and services comprising G.N.P.,it clearly stands up well on the first two of our four requirements;it relates only to goods and services produced within Australia and it relates to all such goods and services. On the other hand, it is rather unsatisfactory from the point of view of the third and fourth requirements. Let us take them in turn.
From the explanation, given earlier,of the way in which the implicit deflator is calculated for any period,it is apparent that a critical element in the calculation is the estimate of G.N.P. at constant prices for the period. In the Australian case this estimate is obtained by making estimates of G.N.P.at constant prices,exports at constant prices and imports at constant prices and then using the identity: G.N.P.at constant prices= G.N.E. at constant prices plus exports at constant prices less imports at constant prices. Thus whether or not the deflator makes proper allowance for quality improvements (third requirement)depends,in the end,on whether or not there is due allowance for quality improvement in the constant-price estimate of G.N.E., exports and imports. In particular it depends on whether there is proper allowance for quality improvement in the constant-price estimate of G.N.E. is the dominant element in the right-hand side of the G.N.P. indentity. If inadequate allowance is made for quality improvement in the constant-price estimate of G.N.E.,the figure for G.N.P.at constant prices will tend to be too low and the figure for the implicit deflator too high. For example,in revaluing the X motor-cars purchased in year t in terms of the prices ruling in some base year (this would be part of the job of making the constant-price estimate of G.N.E.for one year t)one would have to recognise that the number of "base-year"motor-cars purchased in year t was really more than x because the year t motor-car was of better quality than the base-year motor-car.If one failed to take the quality improvement into account, one,s estimate of expenditure on motor-cars in year t in terms of base-year prices would be too low,and,to this extent,one,s figure for the implicit G.N.P. deflator for tear t would be too high.
To determine whether in fact due allowance is made for quality improvement in the Australian constant-price estimates of G.N.E. one must examine the procedures which the statistician uses to make these estimates. If this is done one is forced to the conclusion that,through no fault of his own, the statistician makes a quite inadequate allowance for quality improvement in his constant-price estimate of G.N.E.,and hence that this estimate understates the true constant-price figure,and in tum that the implicit deflator of G.N.P.overstates the extent of the rise in the general price level over any specified time period.
The implicit deflator of G.N.P. falls down,then,in relation to the third of our four requirements. Nor is it satisfactory in terms of the fourth requirement. The main reson is that since G.N.P.includes the value of production of the Australian farm sector as well as the value of production of the non-farm sector,the figure for G.N.P.in current prices for any quarter,say,will reflect price increases caused by production difficulties of a temporary kind in the farm sector. And since the G.N.P. deflator for any quarter is obtained simply by dividing the figure for G.N.P.in current prices by the figure for G.N.P. in constant prices,the deflator must also reflect the temporary price increases,contrary to the fourth of our requirements for an ideal index. A second reason why the implicit G.N.P.deflator is unsatisfactory in terms of the fourth requirement is that,since G.N.P. measures the value of production in the Australian economy as a whole in terms of market prices,the figure for G.N.P.in current prices will reflect price increases caused by the imposition or stiffening of indirect taxes or the removal of subsidies. Hence the implicit deflator of G.N.P. will reflect these price increases also,contrary to the fourth requirement for an ideal index once again.

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