Real GDP and

Inflation
 Gross Domestic Product (GDP)
 GDP = C + G + I + NX
 C = consumer spending
 G = government spending

 I = investment

 NX = net exports
 Two Types of GDP
 Nominal GDP
 GDP that has not been adjusted for inflation

 Real GDP
 The inflation-adjusted measure that reflects the value of
all goods and services produced in a given year
 Inflation

 Two main indexes that measure inflation

 Producer Price Index (PPI)
 Consumer Price Index (CPI)
 Measure of price changes in goods and services
 Most widely used tool to measure inflation
 Sources
 U. S. Department of Commerce, Bureau of
Economic Analysis
 www.bea.gov
 GDP data was comprised quarterly

 U. S. Department of Labor, Bureau of Labor

Statistics
 www.bls.gov
 CPI data was comprised monthly
 What is Inflation
A sustained rise in the general price level; a
situation in which the price of everything goes
up more or less at the same time

“Things get more expensive”

Measured by GDP deflator and Consumer Price

Index (CPI)
 Causes of Inflation
 When the money supply increases faster than
the quantity of goods available increases we
have inflation

 However, as the supply of goods increase, the

money supply has to increase or else prices
actually go down
 CPI
 How we measure inflation
 Time series measured of a weighted average of
prices of a set of goods and services purchased
by consumers
 Can be used to track changes in prices of
goods and service purchased for consumption
by households
CPI Unadjusted
CPI adjusted for energy
 Importance of Inflation
 Inflation affects both Investment and
Consumption

 GDP = C + I + G+ NX
 Inflation and Federal Funds Rate
 Increase in Federal Funds rate
 Decreases the Supply of funds
 More expensive for banks to borrow from each other.
 More expensive to provide loans (prices can rise)

 In other words an increase in the federal funds

rate can cause GDP to decrease
 Regular Inflation Vs. Adjusted
Inflation
 The CPI does take into account inflation
caused by soaring energy prices

 Inflation from CPI less energy and food helps

control for shock effects caused by rising
energy prices.
 P ercen t

0
1

-0.5

-1
0.5
1.5
4 -J a n
4 -F e b
4 -M a r
4 -A p r
4 -M a y
4 -J u n
4 -J u l
4 -A u g
4 -S e p
4 -O c t
4 -N o v
4 -D e c
5 -J a n
5 -F e b
5 -M a r
5 -A p r
5 -M a y
5 -J u n
5 -J u l
Inflation

5 -A u g
5 -S e p
5 -O c t
5 -N o v
5 -D e c
6 -J a n
6 -F e b
6 -M a r
6 -A p r
6 -M a y
Unadjusted Inflation

6 -J u n
6 -J u l
6 -A u g
6 -S e p
6 -O c t
6 -N o v
6 -D e c
7 -J a n
7 -F e b
 Adjusted for Energy Prices
Inflation Less energy and food
1.5

1
Percent

0.5

- 0.5

-1
 GDP Growth Vs. Inflation
GDP Growth Rate and Unadjusted Inflation Rate,
Quarterly
Unadjusted Inflation Rate GDP Growth Rate
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
-0.2 q1 q2 q3 q4 q1 q2 q3 q4 q1 q2 q3 q4
-0.4 04 04 04 04 05 05 05 05 06 06 06 06
-0.6
 Policy Considerations
 Can influence inflation rate by controlling the
amount of money in circulation
 Greater supply of money (without an increase
in quantity of goods and services produced) =
greater risk of inflation
 FOMC can decide to:
 Increase Federal Funds Rate – Head off inflation
 Decrease Federal Funds Rate – Increase money supply,

risking inflation
 Recent FOMC Decisions
 Jan. 2007
 Inflationary pressures may be sustained by resource utilization
 Committee expected a moderation of inflationary pressures
 Concerned about increasing inflation levels

 March 2007
 Again, resource utilization has potential to increase inflation rates
 Committee concerned that inflation risks will not moderate as
expected
 However, most participants expect core inflation to gradually
decline although
 FOMC Recommendations
 Y=C + I + G + (X-M)

 CPI up, not a major inflationary worry

 Although inflation has increased since
December of 2006, it is expected to moderate
 Recommendation: maintain federal funds rate
at 5.25%
 Question 1
 What can the FOMC do to moderate
inflationary pressures?
(A) Increase the Federal Funds Rate
(B) Decrease the Federal Funds Rate
(C) Maintain the current Federal Funds Rate
(D) Federal Funds Rate is not controlled by the
FOMC
 Question 1
What can the FOMC do to moderate
inflationary pressures?
Answer (A) Increase the Federal Funds Rate
 Question 2
 What is the formula for GDP?
(A) GDP = C +I – G + NX
(B) GPD = inflation – CPI
(C) GDP = C + I + G + NX
(D) GDP = adjusted C + I + G + NX
 Question 2
 What is the formula for GDP?
Answer (C) GDP = C + I + G + NX
 Question 3
 What does the Adjusted CPI take into
account?
(A) Energy prices
(B) GDP
(C) Inflation
(D) Energy Prices and food prices
 Question 3
What does the Adjusted CPI take into
account?
Answer (D) Energy and food prices
 Question 4
 What is inflation?
(A) A rise in prices
(B) A rise in CPI
(C) A sustained rise in general prices levels
(D) C but not A and D
 Question 4
 What is inflation?
Answer (C) A sustained rise in general prices
levels