Producer Price Index in U.S. Gets First Overhaul Since 1978

The producer price index has a whole new look. The first major overhaul of the gauge since 1978 more than doubles its reach and provides a more comprehensive view of U.S. inflation at the wholesale level.

The Labor Department’s revamped PPI debuts tomorrow and will include prices received for goods, services, government purchases, exports and construction, encompassing 75 percent of the economy. The old index reflected the costs of goods alone, representing about a third of all production.

Since services represent the biggest part of the economy, the gauge will offer a better look at inflation at the producer level and its scope will be similar to the government’s indexes of prices paid by American consumers. The introduction of services to the mix will also make the reading less volatile than the previous goods-based measure.

“Markets will pay more attention to the new PPI because we’re getting a much broader perspective than before,” said Dana Peterson, an economist at Citigroup Global Markets Inc. in New York. “It has the ability to give us an early indication on what we might expect for consumer inflation. The old PPI had lost its luster because it was missing a chunk of the economy.”

Goods will account for about 24 percent of the revamped gauge, while services -- including financial services, food wholesalers and transportation providers -- make up 63 percent. Prices received from government purchases and exported goods represent 11 percent, and construction is 2 percent.

One of Oldest

The roots of the PPI, one of the U.S. government’s oldest economic data publications, trace back to 1902. The gauge covered the years 1890 through 1901 when it was first published at the dawn of the 20th century, according to the Labor Department. Its origins were derived from an 1891 Senate resolution authorizing the investigation into the effects of tariffs on prices of commodities and factory goods.

Until 1978, the measure was known as the Wholesale Price Index. It is one of three monthly inflation gauges from the Labor Department, which also publishes the import costs series. The consumer-price index, a measure of the cost of living, is the broadest of the three.

The PPI was previously based on the stages of production, ranging from finished goods for consumer spending and capital investment, to intermediate goods, and raw materials. The new concept focuses on all aspects of final demand, namely personal consumption, business investment, government spending and exports.

The Labor Department also will publish price data related to intermediate demand, or business purchases of inputs into production.

Personal Consumption

To the extent that about 68 percent of the PPI will represent the selling prices received by businesses for goods and services going toward consumer spending, it will help provide insight into longer-term changes in the CPI.

At the same time, there are differences. Companies after all receive money for goods and services sold to other businesses, government agencies and overseas customers.

Economists at Citigroup point out that the PPI measure of personal consumption will not capture the implicit rent of owning a home. So-called owners’ equivalent rent accounts for about 24 percent of the CPI. The new PPI will, however, reflect the money hospitals receive for their services. The CPI includes out-of-pocket costs to the consumer for health care, though not what’s paid to the hospital by Medicare or Medicaid.

To make the new PPI readings comparable when they’re released for January, the Labor Department has provided data going back four years on an experimental basis. Based on that, the economy is experiencing inflation in the 1 percent range.

Longer Term

Citigroup economists said that while the overhaul of the PPI didn’t produce a better forecaster of CPI than the previous producer-price series, it does prove useful for observing trends in consumer-level inflation over the longer term.

Inflation running below the Federal Reserve’s target has given the central bank room to keep borrowing costs near zero since 2008 to spur economic growth. Policy makers may take a closer look at the revamped PPI as it complements the CPI and the Fed’s preferred gauge of inflation tied to personal consumption that is published by the Commerce Department.

With its coverage of a wider swathe of the economy, the PPI will provide more insight into what’s driving inflation as producers, depending on the strength of demand and their own pricing power, choose to absorb expenses or pass them along to the consumer.

The new approach “elevates the importance of the PPI,” said Citigroup’s Peterson. It “could potentially be a third useful indicator” for policy makers monitoring inflation trends. “The more information you have, the better. Fed will definitely look favorably on it.”

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