Producer Prices, Inflation, and Deflation

February 20, 2009 • Commentary
This article appeared on National Review (Online) on February 20, 2009

The producer price index (PPI) — a measure of prices at the wholesale level — rose by a surprising 0.8 percent in January, a statistic many have taken as a sign of inflation. Business Week’s Mike Mandell combed through the numbers and disagreed with that assessment: From the fact that producer prices for service industries hadn’t risen at all, he deduced that, rather, “service sector deflation” was impending.

Both the inflation and the deflation worries are overwrought — for the moment.

As for inflation, if we leave out the misleading gyrations in energy prices, the January increase in the PPI was just 0.2 percent. That followed a decline of 0.2 percent in December. Even if January’s 0.2 percent rise persists for a couple of months, that would be a big improvement from the first quarter of 2008 — when the ex‐​energy PPI rose by 0.5 percent a month (a 6 percent annual rate) — or the second and third quarters, when it rose by 0.4 percent a month (4.8 percent).

In fact, such rapid inflation of wholesale costs is one reason profit margins shrank and the economy went into recession: Costs of doing business, even aside from $145 oil and crushing debts, were rising faster than selling prices. The latest PPI figures suggest greatly reduced cost pressure on businesses, although unit labor costs rose faster than prices in the fourth quarter.

As for deflation, producer and consumer prices did fall late last year. But this was no deflation: It was a welcome unwinding of the horrific surge in oil prices in early 2008. These lower prices resulted in real disposable income rising in October, November, and December (after falling for months).

Those who have been too quick to fret about “deflation” should calm down until they have more facts to support their opinion. Those worrying about rising inflation ahead have a sounder theoretical case, but it would be surprising to see inflation data turning up just four months after the Fed began “quantitative easing.” That is not what the PPI shows; even if it did, there’s no evidence that we can use the PPI to predict the CPI.

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