The Producer Price Index (PPI) measures the changes in prices charged by businesses “at the factory gate” for the goods they produce. They are an alternative measure of inflation. Ultimately retailers and distributors will pass on these prices to their customers.
In New Zealand producer price indices divide into two strands: output prices and input prices. Output prices are the “factory gate prices” charged to customers. Input prices are the cost of materials and fuel that manufacturers bear.
In the US, the PPI divides into three: finished goods, intermediate materials and components, and raw materials. The PPI for finished goods is typically the statistic that the media focuses on. Other countries sometimes calculate it differently. Some countries include agriculture as well as manufacturing in the sphere of producer prices. By definition services are not included.
Like the Consumer Price Index (CPI) and its variants, the PPI derives from a basket weighted according to the relative importance of the industry concerned. The basis for the weighting is the value of an industry’s production and how big or small it is in the overall scheme of things. If the widget industry accounts for 5 per cent of GDP, then any changes in the prices it charges its customers will have a 5 per cent weighting in the PPI. Data on prices comes from monthly surveys with recipients selected by means of a stratified random sample. The sample is updated periodically to reflect changes in industrial structure and technology. The index is effectively an average for the month in question. It is usually published about 10 days after the end of the month it covers.
In general terms, the closer the statistic to the final customer, the less volatile it is. So prices of raw materials – including fuel, commodities, feedstock chemicals and materials used in manufacturing – are the most volatile. Prices of intermediate goods and components are less volatile, and prices of finished goods the least volatile. Why is it important for you? One reason stands out. The PPI can be an indicator of future consumer price inflation. But to view it just in this light is an oversimplification – really like comparing apples and pears. This is because the PPI includes capital goods as well as consumer goods, which the CPI does not. Consumer price indices typically also include services, which PPI figures exclude. Having said that, sustained increases (or decreases) in the PPI may be an indicator in general terms that inflationary (or deflationary) pressures are building up.
If so, and though the statistic itself may seem remote from our normal daily lives, it may produce economic policy moves that have a more direct impact on our collective pocket – such as rising interest rates and tighter credit. Conversely, weak PPI data, together with other factors, may encourage the central bank to relax monetary conditions and cut interest rates to attempt to produce a revival in the economy. Recent trends in the PPI have suggested that deflation is more of a risk than inflation.
One problem that policymakers have to contend with is that some components of the PPI – especially input prices – are very volatile on a month-by-month basis. So the interpretation of the figures, and any policy measures that may be taken, needs to take this into account. For this reason too, seasonal adjustment of PPI numbers, though undertaken in the official statistics, is not held to be particularly satisfactory.
In short, PPI indices contain quite a lot of useful information, but much of it is not glamorous or neatly packaged into a number that analysts and commentators can relate to easily. The result is that some of the detail tends to get lost. Commentators are often quick to trumpet any change in any inflation rate as news, even if it is not.