Finding Value in the Producer Price Index (PPI)

The Bureau of Labor Statistics publishes the Producer Price Index (PPI) monthly. This index is essentially the "wholesale index;" in fact, it was once called the whole sale index. However, the index has now expanded to include three primary measures of costs: wholesale, manufacturing and commodities costs. As a result, the new name PPI is more appropriate. The measure is released once a month to reflect the previous month's adjustments. Each month, economic analysts, news stations and other watch closely as the figures are released.

Three Factors of the PPI

There are three smaller indexes within the PPI as a whole. The first is the PPI Commodity Index which measures crude energy costs. These costs encompass crude oil, coal and scrap metal. Any unrefined source of energy that will be refined to produce energy on the next level can be counted in this measure.

The second index is the PPI Stage of Processing (SOP) Index. These goods have been partly manufactured, but they must be refined at some point in the future. For example, cotton that has been refined and processed but not yet made into clothing falls into this category.

The final sub-index is the  PPI Industry Index. This is the heart of the PPI because it measures the cost of the finished goods that will be sold to retailers. This is the "wholesale" index, and it accounts for all goods with the exception of energy and food. 

Significance of the PPI

The main reason analysts tune in so sharply to the PPI is because they believe it has a strong impact on the resulting Consumer Price Index (CPI). The theory is most of the cost increases are passed directly to the consumer through higher retail prices. The higher the cost of crude oil, for example, the higher the cost of unleaded gasoline at the pump. By knowing how much wholesale prices increased in a given period, analysts are more likely to predict price swings in finished goods.

Further, analysts can gain insight into price theory if they notice a spike in one index, but not the other. For example, higher gas prices can easily be explained by higher crude oil costs. However, what if the PPI did not go up when the CPI did? This can be an indicator of higher third-party transfer fees. 

Shortfalls of the PPI

Many economists criticize the PPI model because it uses what is called a "basket of goods" approach. It measures the costs on the wholesale market based on the costs of selected items tracked over time and analyzed according to a specific model. If the basket is not built correctly, the PPI may not accurately reflect market costs at a given moment.

Further, the basket and analytical system changes only every few years. This means the indicator may not match with the current market for some time before it is changed. Ultimately, the PPI is a guide to wholesale prices, but these shortfalls mean it is not accurate accross the board.

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