Reading:
Abel and Bernanke chapter 2, section 4.
Last updated: January 18, 1998. |
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Price Indexes,
Inflation and Interest Rates
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| Real and Nominal Variables Price Indexes and Inflation
GDP Deflator
CPI
Inflation
Interst Rates, Rates of Return and Present
Values
Bond prices
Rates of return
Real interest rate
Expected real interest rate
Links
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- Nominal Variable
- A variable that is measured in current prices
- Example
- Nominal GDP in 1998 is measured in 1998 prices.
- Real Variable
- A variable that is "adjusted for inflation". More formally, a real variable is
measured in the prices of a chosen base year.
- Example
- The current base year for computing real GDP is 1992. Hence, real GDP in 1998 is
computed using the prices that prevailed in 1992.
- Variable Weight Price Index
- Value of current output at current prices divided by the value of current output at base
year prices.
- Example - GDP Deflator
- GDP Deflator = 100*(Nominal GDP)/(real GDP)
Nominal and real GDP |
| Year |
Nominal GDP
(billions of current $) |
GDP Deflator
(1992 = 100) |
Real GDP
(billions of 1992 $) |
| 1990 |
5,546.1 |
93.7 |
5,919.0 |
| 1991 |
5,724.8 |
97.3 |
5,883.7 |
| 1992 |
6,020.2 |
100.0 |
6,020.2 |
| 1993 |
6,343.3 |
102.2 |
6,206.8 |
| 1994 |
6,738.4 |
104.3 |
6,460.6 |
| Source: Survey of Current Business, July 1994 and
August 1995. |
- Fixed Weight Price Index
- Value of a fixed basket of goods at current prices divided by the value of the same
fixed basket of goods at base year prices.
- Example - Consumer Price Index (CPI)
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Operationally, we compute real variables using the following formula
Real Variable = 100*(Nominal variable)/(Price
Index)
where the price index is defined to be equal to 100 in the chosen base year.
- Inflation
- Rate of growth of the genearl price level. Specifically, inflation over a time period is
calculated as the percentage change in a particular price index from one time period to
the next:
inflation = pt+1
= %DPt+1 = (Pt+1 - Pt)/ Pt.
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