Academic journal article Monthly Labor Review

Price Transmission: From Crude Petroleum to Plastics Products: A Structural Vector Autoregression Model Is Used to Analyze the Effects of Crude-Petroleum Supply Shocks on the Market for Organic Chemicals and Plastics Products; the Analysis Demonstrates That Changes in Crude-Petroleum Prices Are Passed on to Prices and Quantities of Organic Chemicals and Plastics Products

Academic journal article Monthly Labor Review

Price Transmission: From Crude Petroleum to Plastics Products: A Structural Vector Autoregression Model Is Used to Analyze the Effects of Crude-Petroleum Supply Shocks on the Market for Organic Chemicals and Plastics Products; the Analysis Demonstrates That Changes in Crude-Petroleum Prices Are Passed on to Prices and Quantities of Organic Chemicals and Plastics Products

Article excerpt

Crude petroleum is an important input used in the production of organic chemicals, which are in turn used as inputs into the production of more-processed goods, such as plastics products. Prices for plastics products compose a substantial portion of several aggregate producer price indexes (PPI's), and these indexes are often looked to as early indicators of consumer inflation. Price changes in crude petroleum, which are transmitted to prices for plastics products, would affect these aggregate PPI's. A thorough knowledge of the relationship between prices for crude petroleum and prices for plastics products, therefore, would help economists understand and explain movements of aggregate PPI's.

The main aggregate PPI's that include prices for plastics products are the indexes for All Commodities, Finished Goods, Finished Goods Excluding Foods and Energy, Intermediate Goods, and Intermediate Goods Excluding Foods and Energy. In December 2005, plastics products accounted for 2.5 percent of the All Commodities PPI. (PPI commodity weights are derived from the 1997 Census of Manufactures and are updated by changes in PPI commodity indexes.) In addition, plastics products accounted for 1.2 percent of the Finished Goods PPI, 2.0 percent of the PPI for Finished Goods Excluding Foods and Energy, 4.6 percent of the Intermediate Goods PPI, and 6.1 percent of the PPI for Intermediate Goods Excluding Foods and Energy. Two of these main aggregate PPI'S exclude prices for energy, insulating them somewhat from energy price inflation; however, price changes in crude petroleum that are transmitted forward to organic chemicals and then to plastics products represent one way in which aggregate PPI's, which exclude energy prices, may still be affected by energy price shocks. In 2005, crude petroleum accounted for 16.8 percent of the Crude Goods PPI and organic chemicals accounted for 4.2 percent of the Intermediate Goods PPI.

The relationship between prices for crude petroleum and prices for plastics products has not been thoroughly examined, but price transmission within the gasoline market is well documented. Using January 1987-August 1996 weekly data on the spot price for West Texas intermediate crude oil, the New York Harbor spot price for unleaded regular motor gasoline, and the self-service pump price for unleaded regular motor gasoline, with and without taxes, Nathan Balke, Stephen Brown, and Mine Yucel estimated a series of bivariate vector autoregression and vector error correction models. (l) Their study indicates that crude petroleum price changes are passed forward to consumer gasoline prices, but that the response of gasoline prices to positive and negative crude petroleum price shocks may be asymmetric. In another study, Michael Burdette and John Zyren used Department of Energy spot and retail gasoline price data to estimate regression models. (2) Their results show that most of the movement in retail prices is determined by previous movements in spot prices. In an earlier Monthly Labor Review article, Jonathan Weinhagen used the PPI's for Crude Petroleum and Gasoline, the CPI for Gasoline, the quantity of domestically consumed gasoline, and the Federal Reserve's index of industrial production to estimate a structural vector autoregression model of the gasoline market. (3) His study reveals that crude petroleum supply shocks significantly affect prices for producer and consumer gasoline. Because the relationship between prices for crude petroleum and prices for plastics products is an area that has seen little research, the analysis that follows attempts to fill the gap by empirically examining price transmission from crude petroleum to plastics products. Toward that end, a structural vector autoregression (VAR) approach is used to examine the effects of crude petroleum price shocks on the market for plastics products from 1974 through 2003.

Price movements of three commodities

The analysis begins with an examination of historical price movements of the PPI's for Crude Petroleum, Organic Chemicals, and Plastics Products. …

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