Numbers #6: Producer Price Index (PPI)

“Excluding food and energy”, how many times have you heard that phrase when there is talk about inflation? Well, here is where that “exclusion” happens…. in calculating the Producer Price Index (PPI).

Wow, this is an incredibly complicated economic measurement of U.S. productivity. It not only tracks the price of “finished goods,” it tracks prices all along the “supply chain” using the “intermediate goods index” and the “crude goods index.”  Dan Caplinger of “The Motley Fool” sums up the function of the PPI nicely, “economists look to the PPI to see evidence of price pressure at the industrial level.” His article entitled “Understanding Economic Data: Producer Price Index” is a short but very informative tutorial on the PPI.

I found this a difficult economic indicator to “wrap around my brain” but hope that you find it informative. As I personally go through the learning curve on all these economic indicators along with you, the reader, I think the waters get murkier rather than clearer, as I  hoped. If you dive into the details of compiling the PPI, you will see how “the numbers” may be interpreted or calculated differently by difference parties.

A comparison

One might ask, “What’s the difference between the Producer Price Index (PPI) and the Consumer Price Index (CPI)?”  The following table gives some highlights of these differences.

Consumer Price Index Producer Price Index
Includes goods and services provided by business or government, where explicit user charges are paid for consumers. Personal consumption portion includes all marketable output sold by domestic producers for households.
Includes imports Excludes imports
Only includes components of personal consumption directly paid for by consumer Includes components of personal consumption that may not be paid for by consumer
Sales and other taxes paid by consumers are part of household expenditure and included Excludes taxes

Source: Bureau of Labor Statistics

A definition

The Producer Price Index (PPI) is a family of indexes that measures the average change over time in selling prices received by domestic producers of goods and services. PPI measures price change from the perspective of the seller. This contrasts with other measures, such as the Consumer Price Index (CPI), that measure price change from the purchaser’s perspective. Sellers’ and purchasers’ prices may differ due to government subsidies, sales and excise taxes, and distribution costs. Source: http://www.bls.gov/ppi/ppiover.htm#coverage

Coverage

About 10,000 PPIs for individual products and groups of products are released each month. PPIs are available for the output of nearly all industries in the goods-producing sectors of the U.S. economy— mining, manufacturing, agriculture, fishing, and forestry— as well as natural gas, electricity, construction, and goods competitive with those made in the producing sectors, such as waste and scrap materials. The PPI program covers approximately 72 percent of the service sector’s output, as measured by revenue reported in the 2007 Economic Census. Data includes industries in the following sectors: wholesale and retail trade; transportation and warehousing; information; finance and insurance; real estate brokering, rental, and leasing; professional, scientific, and technical services; administrative, support, and waste management services; health care and social assistance; and accommodation.

How is the PPI used?

Three major uses are:

As an economic indicator: The PPIs capture price movements prior to the retail level. Therefore, they may foreshadow subsequent price changes for businesses and consumers. The President, Congress, and the Federal Reserve employ these data in formulating fiscal and monetary policies.

As a deflator of other economic series: PPIs are used to adjust other economic time series for price changes and to translate those series into inflation-free dollars. For example, constant-dollar gross domestic product data are estimated using deflators based on PPI data.

As the basis for contract escalation.: PPI data are commonly used in escalating purchase and sales contracts. These contracts typically specify dollar amounts to be paid at some point in the future. It is often desirable to include an escalation clause that accounts for increases in input prices. For example, a long-term contract for bread may be escalated for changes in wheat prices by applying the percent change in the PPI for wheat to the contracted price for bread. For more information on contract escalation and PPIs, see Escalation Guide for Contracting Parties.  Source: http://www.bls.gov/dolfaq/bls_ques15.htm

The above information comes from the U.S. Government’s Bureau of Labor Statistics

Here’s a nice overview of what PPI is: Producer Price Index: CNBC Explains.  Author is Mark Koba, Senior Editor CNBC.

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2 thoughts on “Numbers #6: Producer Price Index (PPI)

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