September 14, 2022
The Producer Price Index for final 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 August after declining 0.5% in July after having risen 1.0% in June and 0.8% in May. In the past twelve months the PPI has risen 8.7%.
Excluding food and energy prices, however, final demand prices rose 0.4% in August after rising 0.3% in July after having climbed 0.4% in June and 0.5% in May. Over the past 12 months this index has risen 7.3%. The recent data provide a hint that these prices are beginning to slow. But it is likely to be a slow gradual process and is not going to get anywhere close to the Fed’s 2.0% target rate any time soon..
We expect to see high inflation as we move forward in time given the very rapid rate of growth in the money supply. Its current 5.3% growth is roughly in line with its average growth during the past decade or so of 6.0%
But, the problem with money growth is the cumulative effect of monthly gains which have consistently been in excess of the 6.0% target. As a result, M-2 currently stands $3.6 trillion above where it should be. That represents $3.6 trillion of excess liquidity in the system which essentially guarantees that inflation will remain elevated for the foreseeable future. Even if the Fed shrinks its balance sheet at the pace it has indicated, there will still be surplus liquidity at the end of next year. That is not a recipe for a significant slowing rate of inflation.
This overall PPI index can be split apart between goods prices and prices for services.
The PPI for final demand of goods fell 1.2% in August after falling 1.7% in July after having jumped 2.3% in June and 1.5% in May. Excluding the volatile food and energy categories the PPI for goods rose 0.2% in both July and August after gaining 0.5% in June after climbing 0.7% in May. This core goods sector inflation index has risen 8.1% in the past year.
Within the goods sector, food prices were unchanged after having jumped 1.3% in July. Typically, this is a volatile series. It increases sharply for a few months and then drops back a few months later. However, in the past year food prices have risen 13.0%. It is likely that fires combined with extreme or exceptional drought conditions in the West is damaging crops and pushing food prices higher, and the war between Russia and Ukraine has interrupted much of the supply of wheat and corn. This is not going to end any time soon.
Energy prices prices fell by 6.0% in August after declining 9.0% in July after having surged by 9.4% in June and 4.8% in May. The war between Russia and Ukraine continues to threaten the supply of natural gas and oil to Europe. At the same time the Biden administration is doing everything in its power to curtail the production of fossil fuels. In the past year energy prices have risen 26.0%. They, too, are not going to decline any time soon.
Prices of services rose0.4% in August after rising 0.2% in July after gaining 0.5% in June and 0.7% in May. In the past year prices of services have risen 6.6%.
The runup in service sector prices is being driven by the transportation category which has risen 17.8%. Within transportation the largest gains have come from deep water shipping (38.6%) and truck shipping (18.3%) as rising diesel prices are boosting the cost of shipping goods via truck.
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. Those labor costs are better captured in the CPI. And right now labor costs are surging as firms scramble to find an adequate supply of labor and are paying higher wages, signing bonuses, and better benefits.
The core CPI rose 5.5% in 2021. In 2022 we look for an increase in the core CPI of 6.0% and 4.4% in 2022.
Stephen Slifer
NumberNomics
Charleston, SC
The vertical axis on your graphs is not labeled and is confusing. It appears the scale reflects the interval change in the rates, not the absolute rates.
Hi Frank. Thanks for your comment. I looked at the PPI chart and I am not sure I understand your confusion. It is the year-over-year percent change in each series. I typically do not show the monthly change in my charts because they tend to be so volatile. With the y-o-y change you can more easily see the change in trend.
Steve Slifer
Steve –
Don’t understand your comment above that the money supply will remain elevated
throughout 2022. I thought the Fed was going to stop QE bond purchases after March and start to shrink their inventory after that. Why will the money supply
remain elevated?
Hi Frank,
A couple of things. First of all, the Fed has said that it will stop its monthly purchases of securities by the end of March. Between now and then its balance sheet and, presumably, money growth will continue to be rapid. It has not yet said when it will begin to actually shrink its balance sheet. Details of that will probably come some time in the first quarter. But at that point it will begin raising interest rates. It seems to me that they will probably not do both simultaneously — kind of a double dose of tightening.
If that is the case, then money supply growth will slow from about 13% currently to perhaps 8% or so next year (remember the Fed keeps buying securities through March). Historically, it needs 5-6% growth (roughly in line with desired nominal GDP growth). But 8% is faster than 5-6%, hence money growth will remain elevated. But going even farther, money growth has been so rapid for so long that its level is far above where it would have been if it had growth 5-6% throughout that period. It actually need 0% money growth for a while to get the level of the money stock back in line with where it should be. To put that another way, it needs to wipe out the excess liquidity that is currently in the economy.
Does that make sense?
Steve