The Producer Price Index (PPI) is an economic measure of the average change in prices received by domestic producers of goods for their products in a given country or region. For more information about the Producer Price Index, you can read the article below. Also follow GIC's Instagram to find out about promos and other information from GIC!

What is the Producer Price Index (PPI)

The Producer Price Index (PPI) is an economic measure of the average change in prices received by domestic producers for their products in a specific country or region. PPI is a metric used in economics to help determine the inflation rate; it is one of many price indices, such as the Consumer Price Index (CPI), that collectively determine the cost of living. The PPI is compiled and published by the U.S. Bureau of Labor Statistics and is one of the oldest economic time series recorded by the federal government. Before 1978, the PPI was called the Wholesale Price Index (WPI), which originated from a U.S. Senate resolution in 1891. Data for the PPI is collected through systematic sampling from producers and is published monthly confidentially and voluntarily by producers. Volatile prices, such as those in the energy sector, are often excluded to keep the index more stable.

How is the PPI used?

Producer Price Index data are widely used by businesses and governments. The three primary uses are: As an economic indicator. In January 2014, the PPI transitioned from the Stage of Processing (SOP) system to the Final Demand-Intermediate Demand (FD-ID) system as its primary index aggregation structure. The transition to the FD-ID system was the culmination of a long-standing PPI goal to improve the SOP (goods produced domestically for domestic, non-government consumption) system by including PPIs for services, construction, government purchases, and exports. The FD portion of the FD-ID system broadens the coverage relative to the finished goods stage of the SOP system by including indices that examine inflation from the perspective of producers for goods, services, and construction sold for personal consumption, capital investment, government purchases, and exports. The ID portion of the system allows data users to examine inflation from the perspective of producers of goods, services, and construction sold to businesses as inputs to production, excluding capital investment. The ID portion of the system includes two parallel treatments of intermediate demand: commodity type and production flow. The commodity type treatment tracks price movements for services purchased by businesses, in addition to price movements for processed and unprocessed goods. The intermediate demand production flow treatment tracks price changes as they pass through the various stages of production. The production flow treatment provides an opportunity to systematically monitor and assess the extent to which changes in the inflation rate faced by producers in the early stages of production are transmitted to subsequent stages, including final demand. President, Congress, The FD-ID index is constructed from commodity-based producer output price indices. These commodity-based output price indices are allocated to aggregate categories based on the proportion of use by type of purchaser. The primary data source used to determine the type of purchaser is the table titled “Commodity Uses by Industry, Before Redefinition” from the United States Benchmark Input-Output Data Tables, produced by the U.S. Bureau of Economic Analysis (BEA). The two major classes of purchasers included in the FD-ID system are final demand (personal consumption, capital investment, government, exports) and intermediate demand (business purchases, excluding capital investment). In many cases, the same commodity is purchased by different types of purchasers, so commodities are often included in multiple FD-ID indices. For example, regular gasoline is purchased for personal consumption, exports, government use, and business use. The PPI program publishes only one commodity index for regular gasoline, which reflects sales to all types of purchasers. This index is used in all FD-ID aggregations, regardless of whether gasoline is sold for personal consumption, as export, to the government, or to businesses, with the differences being accounted for in the weights applied to each FD or ID aggregate index. In some cases, the type of buyer is an important price-determining characteristic, and a commodity index is constructed on that basis. For example, in the PPI category for loan services, separate indices for consumer loans and business loans are constructed. In this case, As a deflator for other economic series. The PPI is used to adjust other economic time series for price changes and to translate those series into inflation-free dollars. For example, constant dollar gross domestic product data are estimated using a deflator based on the PPI data. As a basis for contract adjustments. PPI data are commonly used in adjusting purchase and sale contracts. These contracts typically specify a dollar amount to be paid at some point in the future. It is often desirable to include an adjustment clause that takes into account changes in input prices. For example, a long-term contract for bread can be adjusted for changes in the price of wheat by applying a percentage change in the PPI for wheat to the contract price for bread.


Price Classification in the PPI

PPI classifies price changes based on three major structures – Industry level classification, Commodity classification, and Final Demand – Intermediate Demand (FD-ID).

Industry level PPI classification

It is done in relation to the change in the total net output of an industry. This net output marks the aggregate selling price of products produced in the industry that are sold outside the sector.

Classification of commodities

refers to the categorization done based on products and services. PPI identifies and separates products from an industry depending on their overall similarity, composition, and use.

FD-ID Classification

Based on the end users of products and services. PPI classifies price changes as final demand if the end users are the customers themselves. On the other hand, when products and services reach customers through intermediate channels, price changes are categorized as intermediate demand.

How to Measure the Size of the Producer Price Index (PPI)

Four formulas help calculate the Producer Price Index:

Basic Formula

PPI = Current basket price/Basic basket price Where the basket is the relative weight of goods and services in the current or base period.

Laspeyres Formula

This PPI formula weighs goods proportionally to their quantity in the base year.. PPI (Laspeyres) = (∑q_0 × p_t)/(∑q_0 × p_0 ) x 100 Where, q 0 = quantity in the base period p 0  = product price in the base period p t  = product price in the current year

Formula Paasche

This PPI formula weighs goods in proportion to their quantity in the current year. PPI (Paasche) = (∑q_t × p_t)/(q_t × p_0 ) x 100 Where, q 0 = quantity in the base period q t = quantity in the current year p 0 = price of the product in the base period p t = price of the product in the current year

Fisher's Formula

This formula calculates the PPI as the geometric mean of the PPI (Indeks Laspeyres) and PPI (Indeks Pasche). PPI (Fisher) = (Indeks Laspeyres X Indeks Paasche) = (((∑q_0 × p_t)/(∑q_0× p_0 ) x 100 ) X ((∑q_t × p_t)/(∑q_t × p_0 ) x 100)) Among these formulas, BLS uses the Laspeyres Index formula to calculate PPI.

The Importance of the Producer Price Index (PPI) Indicator

The Producer Price Index, no doubt, helps to assess the level of inflation. In addition, some effective uses of PPI are:
  • Used as a contract adjustment tool to include relevant adjustment clauses in long-term contracts, considering the percentage change in prices.
  • The best parameters to compare input and output price differences
  • Inflation indicators at producer level
  • A measure of inflation for a particular industry or commodity
  • Helps measure the real growth of the economy recorded as Gross Domestic Product (GDP) and distinguishes it from nominal growth.

How is PPI Related to Inflation?

The CPI is a measure of the consumer’s cost of living, so changes in the CPI over time can be used to estimate the rate of inflation as it affects the average citizen. Similarly, changes in the PPI over time are used to estimate wholesale inflation, or “back-end” inflation—how much the cost of doing business increases because of the prices of supplies. The two types of inflation are closely related. If a business has to pay its suppliers more to create consumer-facing products and services, it will typically charge consumers more for those products and services to maintain its margins. In this way, the PPI is a leading indicator—rises in the PPI often directly precede increases in the CPI.

The Impact of the Rise and Fall of the Producer Price Index (PPI) on the Forex Market

There is always a trade-off with money: individuals can save money and earn interest, or they can spend money immediately and forgo the interest payment. If the PPI rises, it can lead to higher interest rates. When interest rates rise, saving becomes more attractive because the rewards (interest) are greater than before. Spending money becomes more expensive because consumers will effectively lose out on higher interest rates when they choose to spend rather than save. As a result, an increase in the PPI can filter into higher rates and a stronger currency. Using the Euro as an example, forex traders know that higher interest rates lead to an increase in financial flows from foreign investors looking to buy Euros for higher yields. This effect tends to drive the value of the Euro higher as demand for Euros increases. A popular strategy to chase higher interest rates is the "carry trade" strategy, where traders borrow funds in currencies with low interest rates and buy currencies with higher interest rates. After learning about the Producer Price Index, how it can be used, its classification, how it is measured, the importance of the PPI indicator, and its effects, you can study more materials through the GIC Journal. And if you want to start trading, register with GIC and start trading from just 150,000 Rupiah!