GDP stands for gross domestic product, which is meant to represent the total dollar value of all goods and services produced over a specific period of time. The CPI, which stands for consumer price index, is a measure of a theoretical basket of goods meant to represent what people are buying. The predetermined basket of goods is averaged and the goods are weighted against one anther based on how important they are to a household. According to investopedia.com, the CPI indicates whether the economy is experiencing inflation, deflation or stagflation. GDP and CPI are, therefore, closely related, though there are some differences.
Inflation and GDP
Inflation is the increase in price over time of a given product or service that is calculated using the CPI. Most economists use the Core CPI to measure inflation, because it excludes food products, which are more volatile pricing. GDP is always adjusted for 6 percent inflation, so if there was only a 2 percent inflation rate, then yearly inflation will be reported as 4 percent, according to investopedia.com
We want economic growth, but not rapid growth. The U.S. government can only sustain a 2.5 to 3.5 percent growth annually. If growth occurs too fast, then inflation grows too fast, making the cost of living, as reported through the CPI, too high for people to keep up. People then cannot afford the new prices, because the trickle down of income to the people is slower than inflation.
CPI, GDP and Cost of Living
When CPI increases, wages have to increase eventually, because the CPI is used to adjust income. The Bureau of Labor and Statistic (BLS) uses the CPI to adjust wages, retirement benefits, tax brackets, and other important economic indicators. However, the government is slower than the markets, and if GDP grows too fast, the government cannot keep up to make all the necessary income adjustments needed for people to maintain a good quality of life because their cost of living increased too fast.
GDP and CPI Direct Correlation
Gross domestic product and the consumer price index are two of the most important aspects of a healthy economy. They directly affect each other, and only stead growth can offset the negative impacts they could have on each other.