The PPI says: Service Sector Deflation is Almost Here

When the producer price numbers were released this morning, everyone fixated, as usual, on the Producer Price Index for Finished Goods. So you can find plenty of sites on the web which will tell you that the PPI for Finished Goods rose by 0.8 percent in January, and by 0.4 percent after taking out food and energy. And most news reports will focus on higher inflation. CNNMoney, for example, has a headline which says “Wholesale prices higher than expected.”

But these types of headlines are deceptive. First of all, it’s better to measure inflation over the past year. By that measure, finished goods prices are down by 1%.

More importantly, finished goods inflation—which is found on the first page of the release—is not the critical piece of data in today’s report. Buried in the back, on pages 21 and 22, the Bureau of Labor Statistics also tracks the prices paid for services—not just the services consumers purchase, but the services that businesses buy as well.

And what these numbers show is that the service sector inflation disappeared in January. That is, producer prices for “traditional service industries” were no higher in January than a year early. They did not rise at all. Nothing. Zero. Service sector deflation, here we come.

This index—which has only been around for a couple of years—strikes me as being a better indicator of the true state of inflation in the U.S. than the finished goods index, or any index connected with manufacturing. Goods inflation is influenced by temporary swings in commodity prices, and by fluctuations in exchange rates. What’s more, the focus on ‘finished goods’ and ‘manufacturing’ may have been appropriate in a manufacturing-based economy of 20 years ago, but it makes no sense in today’s world, where manufacturing is a smaller and smaller share of output and employment.

By contrast, the category of “traditional service industries” includes a very wide range of industries, from health care to telecommunications to web search portals (like Google) to banking to real estate agencies to management consulting to waste collection, amusement parks, and hotels. It is a much better, broader reading of the economy.

The chart above shows the year-over-year change in prices for the traditional service industries, versus the price changes for manufacturing. Manufacturing prices have gone through gyrations with the price of oil and food. But service sector inflation has shown a steady downward trend, hitting an astonishing 0% in January.

There’s no way to know if this is unprecedented, because this data series is relatively new. But let’s just say that service sector deflation—or even flat prices—is highly highly unusual.

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