Index construction
The indices are compiled on the basket principle with weights reflecting the output of each contributor relative to the total. For example, if lacemakers account for 1% of total industrial production, lace prices have a 1% weight in the index.
Weights are generally updated at 5–10 year intervals to take account of the changing structure of industry. Data are acquired by surveys, usually of major companies. The Greek index covers 3,000 price series, the British index over 9,000, and the American index over 100,000.
In many cases returns are collected continuously so that the prices are effectively monthly averages rather than those applying on just one date. Even so, changes one month will not be reflected fully until the following month.
Taxes such as VAT are usually excluded. Excise duties such as on tobacco and alcohol are treated as manufacturers’ costs and are included, so the index moves if they are changed.
13.3 Changes in producer prices
Source: OECD
The cycle
Prices are generally order prices with list prices adjusted by government statisticians to allow for “normal” discounts in each industry. This is fine when the economy is stable, but the PPI may overstate cost pressures when above-average discounts are offered during a recession. Conversely, the PPI understates cost pressures when inflation is rapid; deliveries may be at prices which were negotiated perhaps several months earlier and which are much below current order prices scored in the index.
Use
Producer output prices and consumer prices tend to follow the same path, with producer prices fluctuating more widely. How ever, producer prices generally increase less rapidly than con sumer prices (compare Tables 13.4 and 13.7).
Producer input price indices vary more widely than output prices in response to movements in both commodity prices and exchange rates and are a useful guide to raw materials cost pressures. See the comments on pages 199–200 about the way that pressures feed through the system.
Seasonal adjustment
PPIs are rarely seasonally adjusted. Even if they are, the seasonal adjustment can be suspect, especially on the input side, since, for example, exchange rates do not follow a neat seasonal path. Comparisons over 12 months provide a safer guide to trends, while underlying producer price pressures can often be better identified by examining PPIs excluding items such as food prices, which tend to bump around erratically.
Table 13.3 Producer prices (manufacturing)
Detail
Producer price numbers are usually available at a high level of detail, covering commodity groups (metals, furniture), stages of processing (crude materials, intermediate goods) and industries (farm machinery, capital goods). Watch especially the prices of finished goods in general and of consumer goods.
Special applications
PPIs are frequently used as the basis for price indices for inflation accounting and also for contract price adjustments, often in combination with earnings indices.
Surveys of price expectations
Measures: Manufacturers’ perceptions of inflationary pressures.
Significance: Excellent anecdotal warning of potential price changes.
Presented as: Percentage balances (for example, percentage of those expecting to raise prices).
Focus on: Trend in expectations.
Yardstick: An increase of a few points over a few months is a warning of inflationary pressures.
Released: Monthly; not revised.
Coverage and interpretation
Surveys of price expectations provide excellent inflation indicators usually straight from the horses’ mouths. Various organisations conduct monthly or quarterly surveys (see Business conditions, page 115) in which respondents are asked questions such as: “Do you intend to raise your prices within the next four months?” The balance of those answering yes over those saying no is presented as, say, +20% or (50 + 20) = 70. If a net 20% of respondents expect to lower prices, the balance would be −20% or (50 − 20) = 30.
The absolute balance may not be a good guide, since there may always be an excess of companies planning price rises even in times of low and stable inflation. As a quick guide, see if the latest numbers are above or below figures for recent months; a change in the trend may suggest a potential increase or decrease in cost pressures. Better still, examine a long run of data so that you can put the latest figure in the context of the economic cycle.
Wages, earnings and labour costs
Measures: Labour costs and influences on consumers’ incomes.
Significance: Indicator of both cost and demand pressures.
Presented as: Usually index form, some figures in cash terms.
Focus on: Percentage change over 12 months.
Yardstick: Compare with growth of output and consumer prices. In the OECD, compensation per employee in the business sector rose by 4.5% a year during the period 1990–2007, declining from 7% in 1997 to 3.4% in 2007.
Released: Mainly monthly, at least one month in arrears; revised.
Terminology
Wage rates
Basic pay per period (hour, week, and so on). Manual workers tend to have wages, white collar workers have salaries (are paid monthly).
13.4 Compensation per employee in the business sector
Source: OECD
Earnings
Basic pay plus overtime and bonuses. These may be quoted before or after tax and other deductions. Take-home pay is earnings after deductions.
Wage drift
The tendency for earnings to rise faster than wage rates, for example, due to overtime and bonuses.
Labour costs
Sometimes called total compensation, these are wages and salaries plus pension contributions, payroll taxes such as social security, free meals and a host of other perks. Non-wage costs are 20–50% of labour costs. (See also page 217.)
The Phillips curve
In the 1950s a New Zealand economist, A.W. Phillips, identified an apparent trade-off between unemployment and the rate of increase in wages. His curve suggested that low annual increases in wages are associated with a high unemployment rate; or, conversely, high wage inflation is associated with a low unemployment rate. (See Unemployment, page 68.)
Table 13.4 Hourly earnings in manufacturing
Key figures
Cash totals
Many government and private-sector bodies publish money wage rates and earnings in various industries, sometimes including the cash value of perks such as company cars. The figures are interesting for comparisons between industries, sectors and countries. International comparisons, however, are complicated by differences in coverage, tax regimes and by fluctuations in exchange rates.
Time series
Governments also produce indices showing trends in wages and earnings, while various organisations (including those mentioned in Business conditions, page 115) track pay settlements. These are important indicators of both cost pressures and aggregate demand. Personal incomes (see page 90) offer a better guide to potential consumer demand because earnings are usually quoted before tax and other deductions, often cover only part of total employment and may ignore income from self-employment.
At one extreme, American average weekly earnings exclude salary-earners and cover only production and non-supervisory workers. At the other, British average earnings cover both manual and non-manual employees.
Interpretation
Wages and earnings are closely linked to the economic cycle. When aggregate demand begins to recover after arecession, producers respond first by increasing overtime and earnings rise faster than wage rates. Only when higher demand seems more established do employers take on more workers, which then puts upward pressure on wagerates. When the cycleturns and output begins to decline, overtime is cut first and earnings rise less rapidly or fall. Then staff are laid off. The annual increase in wage rates tends to decline as unemployment rises, although usually with a lag.
A change in av
erage earnings can reflect changes in wage rates, total hours, the mix of standard hours and overtime, output (piecework and profit-sharing), and the relative mix of jobs, grades, industry, and so on.
In general, if earnings are rising faster than consumer price inflation, real spending power is growing. It should be noted, however, that earnings data can be distorted by industrial disputes, delays in implementing pay settlements, lump-sum back pay and temporary lay-offs duringbad weather.
Unit labour costs
Measures: Labour costs per unit of output.
Significance: Indicator of cost pressures and competitiveness.
Presented as: Index form.
Focus on: Percentage change over 12 months.
Yardstick: OECD average unit labour costs in the whole economy rose by 3.7% a year during the period 1990–99 and by 2.0% during the period 2000–08.
Released: At least one month after the end of the quarter; frequently revised.
Significance
Unit labour costs (ULCs) measure the average cost of producing one unit of output; for example, labour costs divided by GDP. This is a key indicator of the cost efficiency of labour. If unit labour costs fall, the same output can be produced for less expenditure on labour.
Unit labour costs reflect two factors, labour costs and productivity. Britain’s rapid increases in unit labour costs in 1989 and 1990 reflected the twin evils of rising wages and falling output, and hence declining productivity.
Table 13.5 Unit labour costs in the whole economy
The cycle
Within the economic cycle, the rate of increase in unit labour costs generally peaks 12–18 months after a peak in activity. When output first begins to fall ULCs rise faster because there is less production for the same spending on labour.
Competitiveness
Relative movements in ULCs are important signals of international competitiveness in traded goods. Businesses in a country where ULCs are rising faster than in other countries might temporarily absorb the pressures by cutting profit margins or improving efficiency.
In the longer term deteriorating competitiveness will reduce exports, output and employment and so eventually tame inflation the hard way. Some economists still advocate devaluation to restore price competitiveness, but experience shows that the initial benefit is quickly eroded by faster inflation.
A fixed exchange rate can impose a useful discipline on pay bargaining.
Consumer or retail prices
Measures: Price of a basket of goods and services.
Significance: Indicates inflation as experienced by a “typical” household.
Presented as: Monthly index numbers.
Focus on: Percentage changes.
Yardstick: OECD average consumer prices rose by 9.3% a year during the 1980s and by 2.8% during the period 2000–08.
Released: Monthly, one month in arrears; quarterly in Australia, New Zealand and Ireland; rarely revised.
Composition
The consumer price index (CPI) is the indicator most people use to track inflation. The index is familiar and readily available, but not necessarily accurate. The European Union’s statistical agency, Eurostat, publishes a harmonised index of consumer prices (HICP) for the EU member states, which is equivalent to Britain’s CPI. Estimates of HICP for individual member states are also published. The European Central Bank’s inflation target is defined in terms of HICP for the 16 euro area countries.
Basket contents and weighting
CPIs measure the cost of a basket of goods and services purchased by the average household each month. The basket’s composition and weighting are usually based on surveys of household or family expenditure habits.
Some indices cover “essentials” only. By careful selection a consumer price index can be dominated by subsidised commod ities and those subject to official price controls. This is how some developing countries keep down their reported consumer price inflation. Most indices, however, cover a fairly full range of discretionary expenditure. Weights are updated annually in Britain and France, but most countries change their weights only every 5–10 years.
Price data
Taxes on expenditure and subsidies are included in CPIs; it would be difficult to exclude them. Other taxes such as those on incomes are excluded, as are savings, life insurance premiums and capital spending.
Prices are usually found by observation, perhaps of over 100,000 items each month. Collection points vary from six state capitals in Australia to over 100 urban centres in France and Germany.
13.5 Changes in consumer prices
Source: OECD
The information is collected by surveys on a particular day so a price change late one month may not be caught in the index until the following month. Indeed, in America, for example, prices of most goods and services other than food and fuel are collected monthly in the five largest geographic areas and every other month in the remaining 80 survey locations. In some other countries major surveys are conducted only every three months.
Housing
The British Retail Price Index and Canada’s index exclude the cost of houses and capital repayments on home loans but include mortgage interest payments. As a result, if interest rates are increased in response to inflationary pressures, the index rises automatically, which is exactly the opposite to the desired and underlying effect. Most other countries use a more satisfactory rental equivalent for measuring housing costs. See also “House prices” below.
Variations
Many countries produce more than one CPI. America has two main indices: the CPI-U for urban consumers (about 87% of the population) and the CPI-W for wage earners (32% of the population).
As well as the headline index, CPI, which excludes most housing costs, Britain also publishes an index excluding mortgage-interest payments (RPIX) and an index excluding mortgage-interest payments and indirect taxes (RPIY). The Bank of England’s inflation target is now defined in terms of the CPI. If mortgage payments were included in the target, then interest rate increases would have the perverse effect of increasing the target measure of inflation.
Table 13.6 Consumer prices
Use and abuse
CPIs are the most timely and best understood inflation indicators. They are often used in setting wage demands and in determining index-linked pay, pension or social welfare payments. They are also used to convert wages and prices of consumer goods (including capital items such as houses) into “real” terms.
Consumer expenditure and GDP deflators are often better guides to inflation, but usually they are not available quickly enough.
Interpretation
Getting at the underlying rate of inflation may not be easy. CPIs are generally not seasonally adjusted and the necessary 12-month comparison is slow to highlight changes in trends. Looking at movements over the latest few months can be misleading because of erratic and distorting factors such as seasonal variations in food prices, annual price-cutting sales promotions, one-off changes in the rate of sales tax and erratic bumps in oil prices.
It is almost always necessary to make adjustments to highlight the “core” rate of inflation. Many statistical agencies produce helpful subindices, usually excluding food and energy prices.
House prices
Measures: Changes in prices of residential property.
Significance: Warning of asset-price bubbles or collapses.
Presented as: Index numbers or average prices.
Focus on: Trends.
Yardstick: Affordability, ie, relationship with incomes.
Released: Mostly monthly, by government, central banks, building societies, private organisations.
Overview
As the asset bubble grew in the 1990s and early 2000s, more attention was drawn to indicators of house prices around the world. Data are in indexed or average value terms and are published by both government and private sources. They can only be a guide as the basket of houses may change or be different in different countries, a
nd the quality and intrinsic value of the same house over time can vary greatly.
You can’t keep ’em down
Houses remain overvalued in many countries where prices are now rising
Housing markets continue to strengthen, as The Economist’s latest survey of global house prices shows. Our periodic round-up was dominated for nearly a year by countries where house prices were falling year-on-year. But the latest available data show that in half of the 20 countries whose markets we monitor, house prices are higher than they were twelve months earlier.
The Economist house-price indicators
Since these indicators were last published at the end of 2009, house-price inflation has quickened in each of the seven countries where it was already positive. In Hong Kong, prices are more than a quarter above their level a year earlier. With the exception of Ireland, the pace of decline has slowed in countries where the market has yet to turn the corner. In America, two of the three measures we follow show that prices remain below their level a year earlier, but the Case-Shiller index of house prices in ten big cities was at the same level in January as it was a year earlier.
Singapore has gone from being one of the most depressed housing markets in the third quarter of 2009 to being the second-frothiest in the three months to March. This effervescence clearly worries its government, which has made it more difficult for buyers to delay mortgage payments and taken steps to deter speculative purchases. In Canada, another country where house prices are rising again, new rules announced in February make it more expensive to buy an investment property and reduce the amount that existing homeowners can borrow against their houses.
Should other countries consider similar steps? That depends in part on a judgment about whether prices have fallen far enough to erase the excesses of the bubble, or whether houses remain overvalued. One way to get at this is to compare the ratio of house prices to rents in a country to its long-run average, as our measure of fair value in housing does.
Guide to Economic Indicators Page 19
