An Empirical Analysis of Price Transmission by Stage of Processing: An Empirical Examination of Causal Price Relationships from a Stage-of-Processing Approach Reveals That Changes in the Indexes for Crude- and Intermediate-Goods Prices Often Preceded Changes in the CPI during the 1970s and 1980s; since the Early 1990s, However, the Relationship Has Become More Tenuous. (Price Transmission)

By Weinhagen, Jonathan | Monthly Labor Review, November 2002 | Go to article overview

An Empirical Analysis of Price Transmission by Stage of Processing: An Empirical Examination of Causal Price Relationships from a Stage-of-Processing Approach Reveals That Changes in the Indexes for Crude- and Intermediate-Goods Prices Often Preceded Changes in the CPI during the 1970s and 1980s; since the Early 1990s, However, the Relationship Has Become More Tenuous. (Price Transmission)


Weinhagen, Jonathan, Monthly Labor Review


In 1978, the Bureau of Labor Statistics began emphasizing the stage-of-processing (SOP) system as the key structure used in analyzing the behavior of producer prices. This system allocates commodities among three categories: crude goods, intermediate goods, and finished goods. Crude goods are defined as unprocessed commodities that are not sold directly to the consumer. Intermediate goods are either commodities that have been processed, but that still require further processing, or nondurable, physically complete goods purchased by business firms as inputs for their operations. Finished goods are commodities that are ready for sale to the final-demand user, either an individual consumer or a business firm. (1) The sop model can be extended to encompass consumer prices by including the Consumer Price Index (CPI) as the fourth "stage of processing."

According to the sop system, commodities at earlier stages of processing can be considered inputs to commodities at later stages of processing. Economic theory predicts that price changes may be transmitted forward through the stages of processing. The study presented in this article (1) uses econometric techniques to determine the causal directions of price changes by means of the sop system and (2) examines the stability over time of the causal relationships found.

Several authors have investigated the causal relationship between commodity prices and consumer inflation. S. Brock Blomberg and Ethan S. Harris examined the relationship between the core CPI, on the one hand, and the Commodity Research Bureau spot index, the Journal of Commerce index, the crude-goods PPI, the National Association of Purchasing Managers price index, and the Federal Reserve Bank of Philadelphia's prices-paid index, on the other. (2) The authors discovered that the commodity indexes had a statistically significant positive effect on core CPI inflation from 1970 to 1986, but that from 1987 to 1994 all of the commodity indexes, except for the Journal of Commerce index, had a negative effect on core CPI inflation. Fred Furlong and Robert Ingenito analyzed the relationship between CPI inflation and the Commodity Research Bureau's indexes for all commodities and for raw materials. (3) The authors showed that both price indexes, excluding oil prices, were strong indicators of CPI inflation in the 1970s and early 1980s, but from the mid-1980s to the mid-1990s, the indexes performed poorly as CPI inflation indicators. Todd Clark studied the relationship between PPI sop models and the CPI by building models that forecast the CPI using producer price indexes. (4) He found that using information about the PPI improved forecasts of the CPI for the overall period from 1977 to 1994 and for the subperiod from 1977 to 1980. However, for the subperiods from 1986 to 1989 and 1991 to 1994, including the PPI in forecasts of the CPI detracted from the forecasts, suggesting a breakdown in the relationship between producer price indexes and the CPI. C. Alan Garner discovered that the explanatory power of the price of gold, the Commodity Research Bureau index of commodities futures prices, the Journal of Commerce index, the Center for International Business Cycle Research index, the Paine Weber index, and the past CPI to explain movements in the current CPI decreased significantly since 1983. (5) Tao-Hwy Lee and Stuart Scott used vector error correction models to examine price transmission within the sop system and found significant forward price transmission from 1985 to 1996. (6) The common finding in the majority of these studies was that the power of commodity prices to predict CPI inflation has diminished since the 1980s.

The next section of this article visually examines historical movements of various PPIS and the CPI in order to study the link between producer and consumer prices. The aim is to confirm or disconfirm previous authors' findings that a change in the nature of the inflationary relationships within the sop system occurred in the late 1980s. …

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An Empirical Analysis of Price Transmission by Stage of Processing: An Empirical Examination of Causal Price Relationships from a Stage-of-Processing Approach Reveals That Changes in the Indexes for Crude- and Intermediate-Goods Prices Often Preceded Changes in the CPI during the 1970s and 1980s; since the Early 1990s, However, the Relationship Has Become More Tenuous. (Price Transmission)
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