Trendspotting on the Producer Price Indices

Which One? Which One Will It Be?

JACKSON HOLE, Wyo. -- The trend in core (excluding food and energy) finished-goods prices is down. The trend in core intermediate- and crude-goods prices is up.

That's the message the Producer Price Indices have been delivering all year, and they sent it again in July.

The core finished-goods index held steady last month (compare to an average monthly increase of 0.1% over the past year). That leaves it growing at a 1.3% year-on-year rate, which marks a deceleration of 1.2 percentage points on its December 1998 peak. (See our economic indicators page for a chart.)

The core intermediate-goods index rose 0.4% last month (compare with an average monthly decrease that rounds to nil over the past year) and has now posted five straight increases for the first time in more than four years. That leaves it falling at a 0.1% year-on-year rate, which marks an acceleration of 1.7 percentage points on its January trough.

The core crude-goods index rose 2.3% last month (compare with an average monthly decrease of 0.9% over the past year) and has now posted three straight increases for the first time in more than two years. That leaves it falling at a 6.6% year-on-year rate, which marks an acceleration of 9.4 percentage points on its December 1998 trough.

And so each of us has a decision to make.

Is the recent deceleration in the core finished-goods index -- note that it has given back only about half of the acceleration it logged last year, when it accelerated to 2.5% from 0.1% between February and December -- just a head fake? Does the recent surge in pipeline pressure paint a truer wholesale price picture?

Or is it the core finished-goods index that's telling the real story?

Shock the Monkey

Your correspondent votes the former. For three reasons.

1. One of these things is not like the others.

   The following Producer Price Indices show an uptrend: the finished-goods index (up since January 1998), the intermediate-goods index (up since December 1998), the core intermediate-goods index (up since January), the crude-goods index (up since November 1998) and the core crude-goods index (up since December 1998).

   The following Producer Price Indices show a downtrend: the core finished-goods index (down since December 1998).

   One could therefore be excused for thinking that it's reeeeally unlikely that the core finished-goods index has it right.

   Especially considering that, in time, increases in food prices (which troughed in March 1998) and in energy prices (which troughed in December 1998) always end up seeping through to the core price measures.

2. That's what the Fed's probably doing.

   Greenspan is known to love the NAPM numbers, and the price index in particular has historically served as a good policy-tightening tell.

   The NAPM price index has posted seven straight increases since December to land at 54.7%, its highest level in almost two years. It now sits 2.5 percentage points above the level at which G. Love pushed through the June tightening, 0.9 point shy of the level at which he pushed through the March 1997 tightening, and 4.2 points shy of the level at which he embarked on the 1994 tightening cycle.

   And so for as long as those comparisons look like that, the core finished-goods index can plunge 10% every month and not mean thing one for policy.

3. Think about what's most likely in the future.

   That's certainly what the Fed ought to be doing. There are some indications that it is.

   Overall economic growth during the past three years has averaged 4% annually, of which roughly 2 percentage points reflected increased productivity and about one point the growth in our working age population. The remainder was drawn from the ever-decreasing pool of available job-seekers without work. That last development represents an unsustainable trend that has been produced by an inclination of households and firms to increase their spending on goods and services beyond the gains in their income from production. That propensity to spend, in turn, has been spurred by the rise in equity and home prices, which our analysis suggests can account for at least 1 percentage point of GDP growth over the past three years. Even if this period of rapid expansion of capital gains comes to an end shortly, there remains a substantial amount in the pipeline to support outsized increases in consumption for many months into the future.

The "even if" sentence is key. Outsized increases in consumption might cause problems down the road -- even if the period of rapid expansion of capital gains comes to and end shortly.

That's pretty much looking ahead.

One indication that inflation risks were rising would be a tendency for labor markets to tighten further. But the FOMC also needs to continue to assess whether the existing degree of pressure in these markets is consistent with sustaining our low-inflation environment. If new data suggest it is likely that the pace of cost and price increases will be picking up, the Federal Reserve will have to act promptly and forcefully so as to preclude imbalances from arising that would only require a more disruptive adjustment later -- one that could impair the expansion and bring into question whether the many gains already made can be sustained.

The "but" sentence is key. The existing degree of pressure might cause problems down the road -- even if labor markets do not tighten further.

That's pretty much looking ahead, too.

The commodity-price crush that sent the Producer Price Indices plunging to begin with came as a result of both financial crises and a (not-unrelated) stagnation in worldwide demand. Growth in the East Asian crisis countries fell a whopping 8.0% between 1997 and 1998, and world gross domestic product growth sank to 1.8% from 3.2% as a result.

Now the world is recovering. The fact that world growth will accelerate only modestly this year is not nearly as important as the fact that we have already hit bottom -- that we will not see growth decelerate by a full 1.4 percentage points again this year.

So why is it that some folks expect the very kind impacts of the shocks we've seen to keep repeating themselves over and over, on out into the future -- why is it that some folks behave and talk and write and forecast as if the impacts have gone from exception to rule -- now that the shocks are gone?

It just doesn't make a whole lot of sense.

Side Dish

Thinking about switching the Dish back to music contests.

The poll thing ain't nearly as novel as it used to be.