South-Western College Publishing - Economics  
PPI Signals Confusion
Subject Inflation
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Producer Price Index, Federal Reserve, Monetary Policy
News Story

Anticipating what the Federal Reserve will do at its next monthly meeting is a popular topic of discussion in Washington, D.C. and Wall Street. So when important economic data like the Producer Price Index (PPI) are released, the numbers are scrutinized for some clear indication as to the direction in which it might cause the Federal Reserve to lean. The Bureau of Labor Statistics announced that the PPI for October fell 0.1 percent; however, the "core" PPI rose 0.3 percent. About the only thing analysts could agree on after reading the report is that the course of inflation is probably more uncertain.

The PPI for October declined by 0.1 percent because of falling prices for gasoline, home heating oil and food. This decline was not expected. Prices for new cars and prescription drugs were noticeably higher in October causing the PPI to rise by 0.3 percent after excluding volatile components like food and energy.

Analysts had been eagerly awaiting the October report, especially since the September figures showed a 1.1 percent increase. This was largely the result of increases in energy, food, tobacco and new car prices. Over the past 12 months, the PPI has increased 2.7 percent. The core PPI is up only 1.9 percent.

Some economists believe that last month's 0.8 percent increase in the core rate plus this month's 0.3 percent are evidence that the core inflation rate will rise and that the Fed will respond at its next meeting by raising interest rates. Other economists note that except for drugs and new car prices, the PPI is flat and, accordingly, the Fed will not raise interest rates. These economists believe that the Fed should react only if there is a wide-scale inflation problem.

(Updated December 1, 1999)

Questions
1. What does the Producer Price Index measure? How is it calculated?
2. What does the Consumer Price Index measure? What is the relationship between the PPI and the CPI?
3. According to the article, the future movement of the PPI is a matter of concern both because it signals what inflation might do and because it can lead the Fed to raise interest rates. Why does the Fed carefully monitor the rate of inflation? Why does the Fed raise interest rates when it thinks that inflation is increasing by an amount they consider to be a problem?
Source John M. Berry, "Producer Prices Fall By 0.1%," The Washington Post, November 11, 1999.

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