Saturday, 19 of August of 2017

Economics. Explained.  


August 10, 2017

The Producer Price Index for final demand – intermediate demand  includes producer prices for goods, as well as prices for construction, services, government purchases, and exports and covers over 75% of domestic production.

Producer prices for final demand fell 0.1% in July after having risen 0.1% in June.  During the past year this inflation measure has risen 2.0%.  It has been bouncing around in a range from 2.0-2.5% for the past six months.

Excluding food and energy producer final demand prices also fell 0.1% after having risen 0.1% in June.  They have risen 1.8% since July of last year.  This series has not climbed above the 2.0% mark since April 2014 but it is obviously getting close.  Some economists are once again beginning to fret about deflation.  Forget about it.  Not going to happen.  This series continues to track near the Fed’s desired 2.0% pace.

This overall index can be split apart between goods prices and prices for services.

The PPI for final demand of goods was unchanged in July after having risen 0.1% in June. These prices have now risen 2.4% in the past year (left scale).  Excluding the volatile food and energy categories the PPI for goods fell 0.1% in July after having risen 0.1% in June.  During the past year the core PPI for goods has risen 2.0% (right scale).  It steadily accelerated for more than a year but has leveled off in recent months.

Food prices were unchanged in July after having jumped 0.6% in June.  Food prices are always volatile.  They can fall sharply for a few months, but then reverse direction quickly.  Over the past year food prices have risen 1.9%.

Energy prices declined 0.3% in July after having fallen 0.5% in June.  Energy prices have risen 4.3% in the past year.  These prices are also very volatile.

The PPI for final demand of services fell 0.2% in July after having risen 0.2% in June.  This series has risen 1.7% over the course of the past year (left scale).  The 2.1% year-over-year increase for May was the largest 12-month increase in this services index since January 2015.  Changes in this component largely reflect a change in margins received by wholesalers and retailers (apparel, jewelry, and footwear in particular).  The PPI for final demand of services excluding trade and transportation rose 0.2% in July after having risen 0.3% in June.  It has climbed 2.0% during the past year.  The 2.2% year-over-year increase for June was the largest 12-month increase thus far in the business cycle.  Once again, any concern about deflation in the United States is totally off base.  Not going to happen.

Because the PPI measures the cost of materials for manufacturers, it is frequently believed to be a leading indicator of what might happen to consumer prices at a somewhat later date.   However, that connection is very loose.

It is important to remember that labor costs represent about two-thirds of the price of a product while materials account for the remaining one-third.  So, a far more important variable in determining what happens to the CPI is labor costs.  With the unemployment rate currently at 4.3%, the labor market is beyond full employment.  As a result, wages pressures are sure to rise, and once that happens firms are almost certain to pass that along to the consumer in the form of higher prices.

Some upward pressure on labor costs, rents, and medicare care will further increase the upward pressure on inflation.  We expect the core CPI to increase 1.9% in  2017 and 2.5% in 2018.

Stephen Slifer


Charleston, SC

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