Transcript Economics, by R. Glenn Hubbard and Anthony Patrick O`Brien

Producer Price Index
(Measures changes in prices paid by businesses)
Web: www.bls.gov/ppi
One revision published with 4 month lag. Annual revision in February.
PPI measures changes in prices that manufacturers and wholesales pay for goods during various stages of production. It is the oldest inflation
measure; index began in 1902. Labor department issues questionnaires to 30,000 firms on 100,000 different items. A basket of goods is
formed to create an index that starts at 100 and reflects average price of goods in 1982. PPI is the first inflation number of the month.
Follow price changes along the production pipeline to determine where price pressures originate.
3 progressive stages of production give rise to 3 price indexes:
PPI Crude Goods – cost of raw materials entering the market for the first time (wheat, cattle, soybeans, coal, crude petroleum, sand, timber). Price
changes can be a function of changing supply which is a function of droughts, freezes, animal disease, geopolitical factors.
Core Crude Goods – (nonfood materials less energy) is a good leading indicator of U.S. and world economic growth. This index responds quickly to
shifts in economic activity. Prices are very sensitive to economic turning points. If businesses expect an increase in future demand, the
demand for metals, paper boxes, timber will rise =>  price crude goods =>  price intermediate goods =>  price final goods. Price
increases move down the production pipeline.
PPI Intermediate Goods – cost of commodities that have undergone transitional processing (flour, paper, auto parts, leather, fabric)
PPI Finished Goods – final processing stage (apparel, furniture, automobiles, meats, gasoline) Products retailers pay for. Total finished goods index
is a measure of inflation in the long-run. Not a perfect leading indicator of consumer price inflation.
There is a link between PPI finished goods and CPI. The two indexes may diverge on a month-to-month basis, but tend to move in tandem and are
correlated over a longer (6-9 month) term. PPI does not include service prices or imported prices, whereas CPI does.
Core PPI Finished Goods – excludes food and energy prices and gives a more accurate reading of the underlying inflation trend. The core rate
index is a proxy for near-term inflation
Inflation, DP/P, is public enemy number one to the financial markets. An  PPI =>  CPI
A 12-month perspective is a better way to view the PPI numbers.
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Market Analysis:
Bonds:  PPI =>  (DP/P)Et+1 =>  DBonds =>  iBonds
Stocks:  PPI =>  production costs =>  profits =>  dividends =>  price stocks
Dollar:  PPI =>  (DP/P)Et+1 =>  ishort-term =>  dollar
Inflation (Producer Price Index)
(year over year % growth)
20%
20%
15%
15%
10%
10%
5%
5%
0%
0%
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
-5%
-5%
-10%
-10%
-15%
-15%
Finished Goods
Intermediate Materials, Supplies, Components
Core Inflation (Producer Price Index)
(year over year % growth)
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
-30%
-35%
-40%
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
Core Finished Goods
Core Crude Goods
Core Intermediate Materials, Supplies, Components
10
11
12
13
40%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
-30%
-35%
-40%
Valve = Price
# of threads = elasticity
Quantity Supplied per year
Inflow/Production
Adam Smith’s
Invisible Hand
Water/Inventory/Stock
Equilibrium Condition
Inflow = Outflow
QS = QD
Determines Price/Valve turns
Quantity demanded
per year
Outflow/Sales
Philadelphia FRB Business Outlook Survey
(Indicator of Manufacturing Activity in Mid-Atlantic Region)
New Orders
Web: www.phil.frb.org/econ/bos/index.html
No monthly revisions. Annual benchmark changes in January.
Unfilled Orders
Shipments = Production – D Inventory
The Business Outlook Survey, BOS, is the longest running FRB manufacturing survey. It measures changes in the industrial sector.
Very timely report. Data is released on the third Thursday of the month it covers and is seasonally adjusted.
Survey is sent to 250 large firms in eastern Pennsylvania, southern New Jersey, and Delaware at the beginning of each month. Survey asks if
activity is up, down or unchanged with respect to: general business activity, new orders, unfilled orders, shipments, inventories, prices paid
and received, number of employees, average employee workweek and capital expenditures.
The survey also asks for firms’ six- month outlook for each variable listed above.
The Philadelphia Fed uses a diffusion index = percentage of positive scores minus percentage of negative scores. A diffusion index of zero is the
breakeven point. Index greater than zero is expansion, less than zero is contraction.
General Business Activity Index – is the most important number from the survey. It has a close correlation with the ISM manufacturing series.
Volatile monthly numbers, however, so use a 3-month moving average to discern a trend.
Six-Month Outlook: Future capital expenditures give an indication of firms’ expectations of future private demand. The Employment Diffusion Index
gives insight into firms’ expectations of the economy’s future direction.
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Market Analysis:
Bonds:  Business Activity Index =>  manufacturing sector =>  DY/Y =>  DP/P =>  DBonds =>  iBonds
Stocks:  Business Activity Index =>  profits =>  PStocks
Dollar:  Business Activity Index =>  manufacturing sector =>  DY/Y =>  DP/P =>  DBonds =>  iBonds =>  dollar
Current and Future General Activity Indexes
Diffusion Index*
(Business Outlook Survey, SA)
80
80
60
60
40
40
20
20
0
0
90
92
94
96
98
00
02
04
06
08
10
12
-20
-20
-40
-40
-60
-80
*Percentage of respondents indicating
an increase minus percentage
indicating a decrease
Recession
6-Month Forecast
Current Activity
-60
-80
Diffusion Index*
Number of Employees & Future Capital Expenditures
(Business Outlook Survey, SA)
50
50
40
40
30
30
20
20
10
10
0
0
90
92
94
96
98
00
02
04
06
08
10
12
-10
-10
-20
-20
-30
-30
-40
-50
Recession
Future Capital Expenditures
Employees
-40
-50