In recent years, the government consumption deflator had been weaker than we expected. This box set out our assumption that the weakness of the government consumption deflator was likely to persist over the forecast period. The box also reviewed the outlook for the household consumption deflator and explained our assumption that this would be broadly equal to CPI inflation in the long run. Taken together with our assumptions for other deflators, these assumptions implied a medium-term GDP deflator growth assumption of 2 per cent, revised down from a previous assumption of 2.5 per cent

We have reassessed the prospects for the growth of the GDP deflator in the medium and long-term based on analysis of its components, in particular the consumption deflator.

There are a number of methodological differences in the construction of the consumption deflator and the CPI. There are also a number of differences in scope, for example the CPI measures the price of Household Final Monetary Consumption Expenditure (HHFMCE) and excludes imputed rents, FISIM, some aspects of life insurance as well as treating package holidays differently. The consumption deflator estimates the price changes for Household Final Consumption Expenditure (HHFCE).a In addition, HHFCE is deflated using other deflators as well as consumer prices, plus some direct volume measures.

Despite these differences, we do not find strong evidence to suggest that the growth rate of the consumption deflator should be substantially different from CPI inflation in the long-run. Consistent National Accounts data for the consumption deflator is now available from 1948 rather than from 1997 only, which shows that the average differences between the two inflation rates since the early 1990s are close to zero. In our current forecast we therefore assume that the consumption deflator will grow at around 2 per cent in the long run, in line with CPI inflation.

Another component of the GDP deflator is the general government consumption deflator. As set out in Box 3.6, real government consumption has held up relatively well over the past two years relative to nominal spending growth. This reflects the way in which measures of real government activity are constructed. In particular, the use of direct measures of real activity may mean that measured real government consumption holds up despite a reduction in nominal consumption growth – implying significantly weaker growth in the implicit price of government consumption. Given this, and the fact that nominal spending growth is forecast to slow further over the forecast period, it seems reasonable to expect the weakness of the government consumption deflator to persist for the foreseeable future. We judge that this could continue to result in below-average growth of the general government consumption deflator over the medium term.

In the medium term, we assume that the remaining components of the GDP deflator are likely to grow at close to their historical rates. Based on this, our medium-term assumption for growth of the GDP deflator is 2 per cent, compared to 2.5 per cent in March. However, in the long run, we expect growth in the GDP deflator to return to closer to 2.2 per cent as the general government consumption deflator returns to its long-run trend growth rate.

This box was originally published in Economic and fiscal outlook – December 2012

a ONS, 2012, Reconciliation of the differences between the Consumer Prices Index and the Implied Price Deflator, March.