Producer input price indices are increasingly rapidly, what’s behind this and will it continue?
Inflation has been in the headlines a lot recently, with the CPI being measured at increasing by 4.9 percent year on year in September. To paint a more complete picture of inflation’s effect on the economy, it is helpful to also consider the prices businesses pay for inputs.
Statistics New Zealand tracks an index of input prices for different industries across the economy. These are aggregated into 55 different industries in the public release data. Conceptually, this measure is the same as the CPI, it asks “how much does this basket of goods increase in price?” Where the basket of goods is simply a basket of inputs to businesses, instead of a basket of consumer goods (as in the CPI).
Like the CPI, this price index has accelerated markedly in the year to September 2021. Showing an increase of 6.2 percent. Historically, input price inflation has been higher than 6.19 percent on a few occasions, notably it was 13.62 percent in the year to September 2008.
The most greatly affected industry has been petroleum and coal product manufacturing, this industry has seen input prices rise 37.06 percent in the year to September. The next highest was basic chemical and chemical product manufacturing with an increase of 21.01 percent. Third was dairy product manufacturing, showing input price increases of 19.34 percent. But why are these industries showing increasing input prices of such large amounts while the CPI increases by just 4.9 percent?
Producer input prices are illuminating because they show how interconnected world economies are. International commodity data shows large increases in the price of steel and chemicals all throughout 2020 and 2021. This is clearly showing up in the industries we summarise.
What we have seen in 2020 and 2021 was a global slowdown on the back of restrictions in economic activity to prevent the spread of SARS-COV-2. The response to the global slowdown was, in almost all countries, an aggressive fiscal and monetary expansion. In lay terms: governments printed money and spent money in order to goose the economy.
The extent of this monetary expansion is shown in the chart below.
This monetary and fiscal expansion to boost the economy was adopted precisely at the same time as restrictions on production in all major economies. Quite obviously supply of all sorts of things was constrained, and against a large increase in demand (from the fiscal and monetary policy) prices could do little else but rise. We note that New Zealand’s M2 does not follow the same path as the other central banks money supplies. The Reserve Bank of New Zealand had already reduced M2 growth before other central banks began to.
The natural question is how much will this input price inflation affect output prices and, ultimately, the CPI. Historically, producer input price increases have not directly affected the CPI. This is consistent with economic theory which tells us that the price of a good affects the cost of producing that good, not the other way around.
A final question is: will this situation accelerate, stabilise, or reverse? Historically, periods of rapid input price increases have been short lived and followed by stabilisation (or even a little reversal). The current situation is different in a lot of ways, but we would expect producer input prices to stabilise in the coming months. Given the extent to which global supply networks have been mangled we would not expect a significant reversal of current price increases within the next year.