Many decision makers in businesses are unsure of how specific
macroeconomic information can apply to the situation that the business
finds itself beyond, “The economy is good” or “The economy is bad.”
Unless your company makes up an economy (e.g., Samsung), generalized
economic information offers little tactical information beyond general
moves such as shrink/expand inventories and cut/add headcount. I would
like to present just one example of how a short dive into some
macroeconomic data can provide actionable information and act as a
starting point for competitive intelligence and self-assessment.
CPI is the consumer price index, which is the most popular inflation index. The target set of items included in the CPI is the set of goods and services purchased for consumption purposes by urban U.S. households.1 PPI, or the producer price index, is a measure of inflation from the businesses’ perspective. The target set of goods and services included in the PPIs is the entire marketed output of U.S. producers. The set includes both goods and services purchased by other producers as inputs to their operations or as capital investment, as well as goods and services purchased by consumers either directly from the service producer or indirectly from a retailer.2 There is also the term “core” CPI (or PPI), which excludes the more volatile prices of food and energy. Sometimes in a newspaper, speaking with colleagues, or listening to the news you hear a phrase so many times, you assume it is true. You will hear in business news statements like the following quite frequently: “Inflation was 3.1% for last quarter, but the less volatile core inflation rate that the central bank pays more attention to was 2.2%.” The underlying assumption is that core CPI is a truer measure of inflation, and the total inflation randomly swings each way around the core CPI. However, it is important to know if the CPI is systematically different from core CPI. Additionally, PPI is explained in textbooks as a leading indicator for CPI, and over the long-term they should be quite similar. However, has there been a divergence between CPI and PPI, and if there has been, what could this mean?
For simplicity, the source used for all graphs is from the bls.gov website.3
Since 1999, core CPI has been systematically lower than total CPI. While it is true that core CPI is less volatile, it is also systematically lower. The cumulative impact of this since 1999 is a price difference of 8%. However, this fact becomes more interesting when the producer’s side of inflation is added.
PPI also outpaces its core. Although CPI outpaced its core by 8%, PPI outpaced its core by 18% since 1999. Inflation in food and energy has hit consumers and producers, easily outpacing the other categories. Also, producers have faced a dramatic increase compared to consumers. How can this information be utilized?
To recap, the four key facts from above are:
The Bottom Line – Conclusions and Tactical Considerations
As more of China and India’s 2.6 billion people see economic improvements, demand has increased for energy, food, and other natural resources. For example, China’s primary energy consumption has more than doubled since 1999.4 Supply for these same resources has not kept pace sufficiently to keep prices tamped down. World demand, USD depreciation against certain currencies, and other factors have contributed to an increase in US food and energy prices. While this analysis focused on the US market, these trends also hold across most countries.
Food and energy are generally considered inelastic goods, meaning that when prices rise, consumers do not cut back on them. This is similar to negative income shock to a consumer. In effect, the consumer must spend more on food and energy, and less on other items. This can also make consumers more cost conscious generally as they seek more utility for their remaining dollars.
Because PPI captures price movements from businesses output, the PPI is commonly understood as a leading indicator of CPI. If this relationship holds, there is a higher chance for increased CPI inflation in the future for food energy, but not for core, as the divergence between PPI core and CPI core has remained relatively constant since 2003.
Because prices have increased more for PPI than CPI, especially in food and energy, businesses will likely push back harder on price increases and be more willing to increase prices on consumers where possible. Many businesses have managed costs over the last five years by improving SG&A, labor costs, and productivity. However, as greater efficiencies in labor become harder to achieve, more attention will be focused on the cost of inputs.
The difference between the PPI and core PPI indices since 1999 is large and has exacerbated over the last three years. Because energy and food have been hit hardest by rising prices, the payoff for increased efficiency in the use of these products have increased. Companies who adapt their processes use these resources more efficiently will maintain a cost advantage. Many companies may think that because they are not in food or high consumption of energy industry, this does not affect them. However, many areas of companies are affected by these price changes, and standard processes may require updated analyses as the payoff for efficiency has increased. A few examples include: style of product packaging (volume, shape, weight, etc.), use of plastics, intermediate food processing waste, transportation utilization and route analysis, IT use and cooling, and machinery setup and batch costs.
1 http://www.bls.gov/ppi/ppifaq.htm. CPI definition.
2 Ibid. PPI definition.
3 bls.gov. The series IDs utilized to create the graphs were CUUR0000SA0 and WPUSOP3000. Where applicable, base year has been changed to 1999 for clarity.
4 See http://www.eia.gov/countries/cab.cfm?fips=CH
CPI is the consumer price index, which is the most popular inflation index. The target set of items included in the CPI is the set of goods and services purchased for consumption purposes by urban U.S. households.1 PPI, or the producer price index, is a measure of inflation from the businesses’ perspective. The target set of goods and services included in the PPIs is the entire marketed output of U.S. producers. The set includes both goods and services purchased by other producers as inputs to their operations or as capital investment, as well as goods and services purchased by consumers either directly from the service producer or indirectly from a retailer.2 There is also the term “core” CPI (or PPI), which excludes the more volatile prices of food and energy. Sometimes in a newspaper, speaking with colleagues, or listening to the news you hear a phrase so many times, you assume it is true. You will hear in business news statements like the following quite frequently: “Inflation was 3.1% for last quarter, but the less volatile core inflation rate that the central bank pays more attention to was 2.2%.” The underlying assumption is that core CPI is a truer measure of inflation, and the total inflation randomly swings each way around the core CPI. However, it is important to know if the CPI is systematically different from core CPI. Additionally, PPI is explained in textbooks as a leading indicator for CPI, and over the long-term they should be quite similar. However, has there been a divergence between CPI and PPI, and if there has been, what could this mean?
For simplicity, the source used for all graphs is from the bls.gov website.3
Since 1999, core CPI has been systematically lower than total CPI. While it is true that core CPI is less volatile, it is also systematically lower. The cumulative impact of this since 1999 is a price difference of 8%. However, this fact becomes more interesting when the producer’s side of inflation is added.
PPI also outpaces its core. Although CPI outpaced its core by 8%, PPI outpaced its core by 18% since 1999. Inflation in food and energy has hit consumers and producers, easily outpacing the other categories. Also, producers have faced a dramatic increase compared to consumers. How can this information be utilized?
To recap, the four key facts from above are:
- CPI has exceeded core CPI by 8% since 1998.
- PPI has exceeded core PPI by 18% since 1998.
- PPI has grown by 8% more than CPI since 1999.
- Core CPI has grown by 5% more than Core PPI since 1999.
The Bottom Line – Conclusions and Tactical Considerations
As more of China and India’s 2.6 billion people see economic improvements, demand has increased for energy, food, and other natural resources. For example, China’s primary energy consumption has more than doubled since 1999.4 Supply for these same resources has not kept pace sufficiently to keep prices tamped down. World demand, USD depreciation against certain currencies, and other factors have contributed to an increase in US food and energy prices. While this analysis focused on the US market, these trends also hold across most countries.
Food and energy are generally considered inelastic goods, meaning that when prices rise, consumers do not cut back on them. This is similar to negative income shock to a consumer. In effect, the consumer must spend more on food and energy, and less on other items. This can also make consumers more cost conscious generally as they seek more utility for their remaining dollars.
Because PPI captures price movements from businesses output, the PPI is commonly understood as a leading indicator of CPI. If this relationship holds, there is a higher chance for increased CPI inflation in the future for food energy, but not for core, as the divergence between PPI core and CPI core has remained relatively constant since 2003.
Because prices have increased more for PPI than CPI, especially in food and energy, businesses will likely push back harder on price increases and be more willing to increase prices on consumers where possible. Many businesses have managed costs over the last five years by improving SG&A, labor costs, and productivity. However, as greater efficiencies in labor become harder to achieve, more attention will be focused on the cost of inputs.
The difference between the PPI and core PPI indices since 1999 is large and has exacerbated over the last three years. Because energy and food have been hit hardest by rising prices, the payoff for increased efficiency in the use of these products have increased. Companies who adapt their processes use these resources more efficiently will maintain a cost advantage. Many companies may think that because they are not in food or high consumption of energy industry, this does not affect them. However, many areas of companies are affected by these price changes, and standard processes may require updated analyses as the payoff for efficiency has increased. A few examples include: style of product packaging (volume, shape, weight, etc.), use of plastics, intermediate food processing waste, transportation utilization and route analysis, IT use and cooling, and machinery setup and batch costs.
1 http://www.bls.gov/ppi/ppifaq.htm. CPI definition.
2 Ibid. PPI definition.
3 bls.gov. The series IDs utilized to create the graphs were CUUR0000SA0 and WPUSOP3000. Where applicable, base year has been changed to 1999 for clarity.
4 See http://www.eia.gov/countries/cab.cfm?fips=CH
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