The headline GDP numbers this week said the economy grew at a 1.9% rate in the second quarter. Like most government numbers, things aren't nearly so rosy once you get past the headlines.
The first thing you have to understand is what the GDP Deflator is.

the GDP deflator (implicit price deflator for GDP) is a measure of the change in prices of all new, domestically produced, final goods and services in an economy.
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In practice, the difference between the deflator and a price index like the CPI is often relatively small.

Very quietly, and long after everyone stopped caring, the government revised GDP growth lower for every year between 2004 and 2007.

Between hedonics, substitution and geometric weighting, the CPI is already a flawed and chronically understated measurement of price inflation. However, that's a topic for another day. Today we are going to look at the differences between the reported GDP, and what the GDP would look like if the price deflator resembled something closer to reality.

When the Q4 2007 GDP growth was revised from +0.6% to -0.2%, half of that was due to the deflator being revised upwards from 2.44% to 2.84%. In Q1 2008, the revised inflation figure was 2.63%. So we're in a world of inflation somewhere between 2.5% and 3.0%? Not according to the Q2 2008 deflator, which was a very low 1.06%.

If inflation was running at a 2.5% pace in Q2, then growth would come down to just 0.5%.

A real inflation rate of 2.5% would be wonderful. Not only would it knock the GDP down to almost nothing, it would still only be about half of what the CPI was during the past quarter.

For the record, import prices rose at a 28.6% annual rate in the second quarter, a pace that would be comforting only in Zimbabwe (which lopped 10 zeroes off its currency last week).

The GDP data show that domestic prices actually rose at a 4.2% clip in the second quarter. If that rate of inflation, which is in line with the consumer price index, were applied to the overall economy, GDP would have shrunk at a 1.2% annual rate.

Even this is an understatement. From June 2007 to June 2008 the CPI ran at a 5.6% rate, which makes the act of using a GDP deflator of 2.5% a bad joke. In fact the CPI for just the month of June was 1.1%, almost the exact same number that they used to calculate the deflator for the entire 2nd quarter.

Some of you might be thinking, "That's consumer prices. What about producer prices?"
If producer prices were factored in then the inflation numbers would be that much higher.

During the first 6 months of 2008, the finished goods index rose at a 12.4-percent seasonally adjusted annual rate (SAAR) after increasing at a 5.8-percent SAAR during the second half of 2007. Prices for finished energy goods climbed at a 38.1-percent SAAR from December 2007 to June 2008 after rising at a 16.7-percent SAAR for the 6 months ended December 2007.

In other words, there is simply no way that the economy could have done anything other than shrunk, and shrunk by a great deal, in the 2nd quarter without the government resorting to using bogus numbers.