Two Measures of Inflation in Theory and in the Context of New Zealand

Today’s post takes a closer look at two common measures of inflation, namely the Consumer Price Index (CPI) and the GDP deflator. The first part looks at key differences between inflation measured by the former and the latter indicator. In the second part I take a closer look at CPI and GDP deflator inflation in the context of New Zealand from 2000 to 2014 and the Reserve Bank of New Zealand’s performance in inflation targeting. This was part of a bigger assignment for my Macroeconomics in the Global Environment class. However, I think that it is valuable content for a blog post.

Two common measures of inflation are (1) the Consumer Price Index (CPI) and (2) the GDP deflator. Over the long-run they tend to move together. However, they can diverge for two reasons due to the way they are constructed.

Firstly, the CPI is based on a basket of goods and services, which proxies for the consumption of an average household. Because consumers do not only consume domestic goods, the CPI does include foreign consumption goods. The GDP deflator, on the other hand, only tracks domestic produce, because GDP measures all goods and services produced within a country. This also includes things like investment, which are not considered in the CPI, so that the composition of the baskets differs significantly. Overall, the CPI can rise due to price rises in imported goods while the GDP deflator can only rise if prices of domestic goods and services, investment etc. increase. This matters especially for small open economies which export most of their produce but import most of the goods and services consumed domestically. A good example is oil. When a country relies mostly on oil imports, then oil and oil-based products make up a much larger share of the CPI than of GDP. Therefore oil price changes weigh more on the CPI than the GDP deflator in this case (Mankiw, 2008).

Secondly, the components of the CPI basket are fixed, exogenously determined by Statistics New Zealand, while the GDP deflator’s basket can change over time. This is because the GDP deflator compares the prices of currently produced (domestic) goods to the prices of goods produced in the base year. Its basket is a unit of GDP, no matter what the GDP contains (Thoma, 2008). This can cause the CPI and the GDP deflator to diverge if the GDP deflator basket adjusts over time and the prices of the goods do not change proportionally (Mankiw, 2008).

The context for the following analysis of CPI inflation and GDP deflator inflation in New Zealand from 2000 to 2015 is that the Reserve Bank of New Zealand has officially pursued CPI inflation targeting to maintain price stability since the Reserve Bank of New Zealand Act 1989. This Policy Targets Agreement (PTA) set out a CPI inflation band of 0 to 2 percent per year. The PTA was last changed in September 2002 to a band of 1 to 3 percent per year. In the short-run, inflation is allowed to exceed the band but for no longer than 12 months (RBNZ, 2009). The Reserve Bank’s prime tool for inflation targeting is the Official Cash Rate (OCR). The bank reviews the OCR 8 times per year to achieve a 2 percent inflation target midpoint (RBNZ, 2016).

New Zealand Inflation 1
(Source: World Bank, 2016; own calculations)

Figure 1 shows inflation measured by the GDP deflator and the CPI for New Zealand from 2000 to 2015. Furthermore, it includes the difference between the two indicators by subtracting GDP deflator inflation from CPI inflation. It can be seen that the two inflation measures have diverged considerably in the case of New Zealand over the last couple of years. Inflation measured by the CPI was lowest in 2015 at 0.23 percent. It was highest in 2011 at around 4.43 percent. Overall, New Zealand’s Reserve Bank missed its CPI inflation target 7 out of 13 years since 2003 after the last band amendment.

Inflation measured by the GDP deflator was highest in 2007 at 5.19 percent inflation per annum. The lowest inflation occurred in 2012 with almost perfect price stability (0.03 percent), closely followed by the year 2002 (0.26 percent). Overall, GDP deflator inflation has been more volatile than CPI inflation. This, however, is at odds with the existing economic theory that the CPI tends to be much more volatile than the GDP deflator (Sexton, 2016). The positive divergence of the two measures was greatest in 2002 and 2011 with a difference of 2.4 percentage points. The greatest negative divergence occurred in 2007 and 2013 with 2.8 percentage points and 2.7 percentage points, respectively.

New Zealand is a small open economy and domestic consumption depends largely on imports. Hence any price increases abroad are transferred into the economy and are hard to tackle with monetary policy (inflation targeting) of the Reserve Bank.  This imported inflation can partly explain the spikes in the CPI of 2008 and 2011. In 2008, CPI inflation was mainly driven by rising petrol prices. New Zealand relies mostly on imported fuel from refineries in Asia, the Middle East and the Pacific (Ministry of Business, Innovation and Employment, 2015). The oil supply shock of 2008 pushed CPI inflation briefly above 5 percent (Statistics NZ, 2016). In 2011, CPI inflation was driven by higher prices in the categories transport, food and housing, as well as due to a GST (indirect tax) increase (Tarrant, 2011).

The rise in the GDP deflator from 2002 to 2003 might be explained by higher prices for key exports such as milk, butter, cheese and meat as well as higher grain prices (Statistics New Zealand, 2010; 2011). It could be argued that these production and export price increases are only indirectly reflected in the CPI through final consumption expenditures while they have a larger impact on New Zealand’s nominal GDP and therefore the deflator. Secondly, the land and housing bubble might have caused stronger GDP deflator inflation. Land, for example, is not included in the CPI anymore, but it saw a significant price rise over the period from 2001 to 2007, especially in Auckland (Zheng, 2013). Also the commercial property investment boom with the total value of sales increasing from $2.87 billion (2001) to $7.13 billion in 2007 and the subsequent drop to $4.04 billion in 2008 might explain the large difference between inflation rates in 2007 (Colliers International, 2015).

New Zealand Inflation 2
(Source: World Bank, 2016; own calculations)

Figure 2 shows the inflation trend over the period together with the lower and upper bound of the Reserve Bank’s inflation targeting strategy. The log difference of the CPI and the GDP deflator are equal to the respective inflation rates. The logarithmic scale also ensures that the percentage changes have the same vertical distance on the scale so that one can (1) include the linear inflation trend bounds and (2) estimate linear trend lines for both the CPI and the GDP deflator. Overall, the CPI index has grown by 2.59 percent on average while the GDP deflator has risen by 2.52 percent on average per year.  The Reserve Bank has therefore been successful in keeping inflation within the band on average and in the long-run while often failing in the short-run as noted above. This short run failure in controlling CPI inflation likely stems from imported inflation as New Zealand’s domestic consumption falls largely on foreign goods which the Reserve Bank cannot control. Furthermore, it can be seen that the bank kept inflation more closely to the upper bound than the 2 percent inflation target midpoint in the long run.

The diagram also reveals that after 2008 the indices have fluctuated more from another. The GDP deflator overtook the CPI in 2009 and 2010 as well as in 2013 and 2014. While CPI inflation has come down closer to the 2 percent midpoint target since 2011, the GDP deflator has been taking off.

So that’s me for today. I hope this blog post shed light on key differences between the CPI and the GDP deflator and why inflation measured by the indicators can differ at least in the short run. This is important especially for small open economies such as New Zealand. The second part of the post showed that CPI and GDP deflator inflation rates in New Zealand differed significantly over the period from 2000 to 2014 which is not normally the case. For example, if you were to plot the series for Germany they would differ less, because (1) the country consumes more of what it also produces and relies less on imports and (2) is also a significantly larger economy. Finally, the post also looked at how well the Reserve Bank performed at targeting a CPI inflation rate of between 1 to 3 percent.

Thanks for reading!


Colliers International (2015). New Zealand Capital Markets Report: New Zealand Unleashed Q2 2015. Auckland: Colliers International. Retrieved from:

Mankiw, N.G. (2008). Principles of Macroeconomics (5th ed.). Mason, O.H.: South-Western Cengage Learning.

Ministry of Business, Innovation and Employment (2015). Fuel industry in New Zealand. Retrieved from:

RBNZ (2009). Explaining New Zealand’s Monetary Policy [pdf]. Retrieved from:

RBNZ (2016). Official Cash Rate (OCR) decisions and current rate. Retrieved from:

Sexton, R.L. (2016). Exploring Economics (7th ed.). Boston, M.A.: Cengage Learning.

Statistics New Zealand (2010). Slicing and dicing meat and poultry prices. Retrieved from:

Statistics New Zealand (2011). Tracking milk prices in the CPI. Retrieved from:

Statistics NZ (2016). 100 years of CPI – Price changes 1994-2014. Retrieved from:

Tarrant, A. (2011). NZ CPI hits 21 yr high of 5.3% on rising petrol, food, housing prices, Stats NZ says; Even without GST hike, inflation above RBNZ band. Retrieved from:

Thoma, M. (2008, 3 September). The GDP Deflator and the Inflation Rate. Retrieved from:

World Bank (2016). World Development Indicators: New Zealand [Data file]. Retrieved from:

Zheng, G. (2013). The effect of Auckland’s Metropolitan Urban Limit on land prices. Wellington: The New Zealand Productivity Commission. Retrieved from:


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