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short essays and reports on the economic issues of the day
2003 ■ Number 5

PPI versus CPI Inflation
William T. Gavin
n November and December of 2002, the producer
widely dispersed in the past five years. The food component
price index (PPI) declined unexpectedly, contributing
of the CPI increased at an average rate of 2.2 percent—
to concerns about deflation. In November, the PPI for
which is close to the all-item CPI inflation rate (2.3 percent).
finished goods fell 0.4 percent. In December, although
Four components had lower average price increases than
analysts expected a 0.3 percent increase, it was unchanged.
the all-item CPI: apparel (–1.6 percent), transportation
In each of these months the core PPI (that is, the PPI
(1.5 percent), recreation (1.3 percent), and education and
excluding food and energy) surprised analysts by falling
communications (1.8 percent). The fall in electronic equip0.3 percent.
ment prices has helped moderate the relative rise in comShould we be concerned about declines in the PPI as a
munications prices. Three components had higher average
possible harbinger of economy-wide deflation? The chart,
price increases than the all-item CPI: housing (2.8 percent),
which presents a long-run perspective on the consumer
medical care (4.1 percent), and the “other” category (5.0
price index (CPI) and the PPI, includes four price measures
percent). The “other” category includes tobacco products
that are indexed to one in January 1967: (i) the PPI, (ii) the
and personal care services.
all-item CPI, and (iii) the services and (iv) goods compoWe should not be too concerned about price declines
nents of the CPI. Since at least 1980, services prices have
in the PPI (or any subset of the CPI basket) as long as the
tended to rise relative to goods prices. In just the past five
broad price indexes such as the CPI are stable. If CPI inflayears, the services component of the CPI has increased at
tion remains at about 2 percent per year, then recent trends
an average rate of 3.2 percent per year, while the goods
suggest that the PPI will increase at a rate of about 1 percent.
component has increased at only a 1.1 percent rate.
Similarly, CPI inflation would have to be below 1 percent
Why have goods prices risen so much more slowly than
before we would expect to see ongoing price declines in
services prices? The answer, as shown by the data, is trementhe goods sector. ■
dous advances in technology and productivity in goods
production. For example, the
PPI component for electronic
computers and computer
Price Indexes
equipment has fallen an average of 12.3 percent per year
Index, 1967 = 1
for the past five years. Com CPI-Services
Average Price Increases for Past Five Years
puter prices are expected to
CPI-Services 3.2
decline far into the future,
CPI-All Items 2.3
CPI-All Items
and no one thinks that this is
CPI-Goods 1.1
a sign of deflation. Rather, it
is a sign of technological
advances and cost saving in
computer manufacturing.
The average price changes
for the eight major compo1977
nents of the CPI have been


Views expressed do not necessarily reflect official positions of the Federal Reserve System.