It is sometimes assumed that the direction and magnitude of price changes in the Producer Price Index (PPI) will anticipate or parallel similar changes in the Consumer Price Index (CPI) for All Items. When this assumed relationship is contradicted by actual index changes, many data users ask why the PPI and CPI show different price movements.
The answer is that conceptual and definitional differences between the PPI and CPI—differences which are consistent with the uses of the two measures—contribute to the differences in their price movements. A primary use of the PPI is to deflate revenue streams in order to measure real growth in output. A primary use of the CPI is to adjust income and expenditure streams for changes in the cost of living. The different uses result in definitional differences that can be categorized into three critical areas: (1) scope and coverage, (2) categorization, and (3) other technical differences.
Within the PPI, the index that most closely aligns with the CPI for All Items is the Personal Consumption PPI, a substantial component of Final Demand within the PPI’s primary aggregation model, the Final-Demand-Intermediate Demand system. In terms of goods, the PPI for personal consumption tracks changes in manufacturer selling prices for consumer foods, consumer energy goods, consumer durable goods, and consumer nondurable goods other than food and energy. From the services perspective, the Personal Consumption Index tracks changes in prices received by services producers for transportation of private passengers, transportation and warehousing of personal consumption goods, wholesale and retail trade in personal consumption goods, and services other than trade, transportation, and warehousing sold to personal consumption. The All Items CPI for All Urban Consumers (CPI-U), U.S. city average, measures the average change in prices urban consumers pay for goods and services.
More information about the PPI FD–ID system is available by linking to “A new, experimental system of indexes from the PPI program” in the February 2011 issue of the Monthly Labor Review, or by visiting the FD-ID Aggregation System webpage. Detailed documentation of PPI methodology is available from the PPI chapter of the BLS Handbook of Methods, and similar detail regarding the CPI is available by linking to the CPI chapter of the Handbook.
The scope of the PPI for personal consumption includes all marketable output sold by domestic producers to the personal consumption sector of the economy. The majority of the marketable output sold by domestic producers comes from the private sector; however, government produces some marketable output that is within the PPI’s scope. In contrast to the PPI’s scope, that of the CPI includes goods and services provided by business or government when explicit user charges are assessed and the goods or services are paid for by consumers.
The most heavily weighted item in the All Items CPI, owners’ equivalent rent, accounts for approximately 24 percent of the overall index. Owners’ equivalent rent is the implicit rent that owner occupants would have to pay if they were renting their homes and is included in the CPI in order to capture the cost of shelter for owner-occupied housing units. The PPI for personal consumption does not include owners’ equivalent rent within its scope, because owners’ equivalent rent is not a domestically produced, marketable output.
The PPI for personal consumption and the CPI also differ in their treatment of imports. The CPI includes within its scope goods and services purchased by domestic consumers and therefore includes imports. The PPI, in contrast, does not include imports, because imports are by definition not produced by domestic firms. Imports compose a substantial portion of the CPI, especially within the apparel and new-cars component, and their inclusion in the CPI and exclusion in the PPI for personal consumption causes a substantial difference between the two indexes.
The CPI includes only components of personal consumption that are directly paid for by the consumer, whereas the PPI for personal consumption includes components of personal consumption that are not paid for by the consumer. For example, the PPI for personal consumption includes medical services that are paid for by third parties such as employers or the federal government. The CPI, by contrast, includes only payments made directly by consumers for medical care. In December 2011, medical care services composed 23.1 percent of the PPI for personal consumption but only 5.3 percent of the All Items CPI.
A final difference in scope between the PPI and the CPI occurs for services whose prices contain an interest rate component. The CPI’s scope excludes changes in interest rates or interest costs. The scope of the CPI includes services, such as banking services and insurance services, whose prices have an interest rate component, but the interest rate component of these services is not included in the index. The scope of the PPI also encompasses services whose prices include an interest rate component, but this index includes the interest rate component of those prices. Banking services account for approximately 4 percent of the PPI for personal consumption, and insurance services compose 3.8 percent. Within the PPI, changes in interest rates will affect price indexes for banking and insurance. The scope of the CPI includes some banking services, such as ATM fees, and many insurance services; however, the interest rate component of these services is not included. Changes in interest rates therefore do not affect the CPI.
In contrast to the CPI, the PPI does not currently have complete coverage of services. In the mid-1980s, the Bureau began expanding PPI coverage beyond mining, manufacturing, agriculture, and utilities, introducing its first services price index in 1985. The effort to expand coverage into the services sector of the economy is ongoing. The PPI currently covers approximately 72 percent of services, as measured by 2007 Census revenue figures for the sector. Because the PPI does not have complete coverage of services, a number of services are included in the CPI that are not included in the PPI for personal consumption. Among the most important of these services are residential rent, accounting for approximately 6.5 percent of the CPI, and education services, composing slightly more than 3 percent of the CPI.
The PPI and the CPI categorize a number of goods and services differently within their index structures. Differences in categorization for goods and services are mitigated at high levels of aggregation but can create discrepancies at lower levels. The PPI, for example, classifies utilities, such as electric power and natural gas, as goods, while the CPI categorizes utilities as services. The overall PPI for personal consumption and the CPI both include utilities; however, the PPI for personal consumption services excludes utilities, while the CPI for services includes utilities, making the two services indexes less comparable than the overall indexes.
The PPI and the CPI also differ in their categorization and treatment of trade and transportation. The PPI generally separates the costs of transporting, retailing, and wholesaling goods from the cost of the good itself and classifies trade and transportation as services. In contrast, prices for goods as measured by the CPI typically include the value of the good, the value of transporting the good, and the trade margins associated with the sale of the good.
Several other technical differences exist between the PPI for personal consumption and the CPI. The PPI and the CPI are both constructed with the use of a modified Laspeyres index formula, but the CPI updates weights every 2 years and the PPI updates weights every 5 years. The CPI also implements a geometric mean formula at the item level that the PPI does not. The geometric calculation reduces substitution bias, leading to lower measures of inflation in periods of price increases. The PPI attempts to collect prices for a specific day of the month (the Tuesday of the week containing the 13th), while the CPI collects prices throughout the month. Finally, prices measured by the CPI include sales and excise taxes, while prices measured by the PPI exclude those taxes.
More information comparing the PPI FD–ID system with other data is available by linking to "Comparing new final-demand producer price indexes with other government price indexes" in the January 2014 issue of the Monthly Labor Review. The PPI homepage contains additional information regarding PPI data and methodology. For further assistance, contact the PPI Section of Index Analysis and Public Information at (202) 691-7705 or firstname.lastname@example.org.
Last Modified Date: February 19, 2014