At Angry Bear, Kash has an interesting take on yesterday's report of producer price inflation in December. First, the facts, from the AP via the Washington Post:
The Labor Department reported that its Producer Price Index, which measures price pressures before they reach the consumer, rose 0.9 percent in December. The culprit was a big surge in gasoline prices, which rose 12.3 percent after falling 10.7 percent in November.
For all of 2005, producer prices rose by 5.4 percent, compared with a 4.1 percent increase in 2004. Both gains were the biggest since a 5.7 percent rise in 1990, a year when Iraq's invasion of Kuwait sent global energy prices soaring.
However, core inflation, excluding energy and food, was up a more moderate 1.7 percent in 2005, including a tiny 0.1 percent increase in December.
Kash picks up on this divergence between energy price inflation (measured by the energy component of finished producer goods) and all other finished good producer prices:
Why haven't firms passed on their higher energy costs? Presumably it's because they haven't been able to charge higher prices, not because they haven't wanted to. This could be the case if the demand for non-energy products by firms has fallen a bit as firms have had to spend more of their budgets on energy products. In other words, firms are simply shifting the allocation of their spending away from non-energy products and toward energy products.
This is a point that applies to consumers as well. I often hear the assertion that higher prices at the gas pump, for example, will cause households to reduce their overall spending because they are somehow poorer. There is a sense in which this is true. A rise in the relative price of anything -- be it gasoline, apples, or medical care -- means that consumers are unable to purchase the same bundle of goods and services, with the same income, as was possible before the price change. (In case you are tempted to say "but I could dip into my saving to maintain my standard of living", note that reducing your saving means that your ability to purchase future goods and services is diminished.) But a change in the composition of expenditure is not the same thing as a decrease in total demand. Furthermore, we would fully expect a change in expenditures from one set of goods and services to another to accelerate the pace of price change for the latter, and mute the pace of change for the former. Kudos to Kash for the useful reminder.
I'm less certain about this claim:
One interpretation of this phenomenon is that it is a symptom of weak aggregate demand. If aggregate demand were higher, then firms would be in a better position to pass on their higher energy costs. The fact that the discrepancy between energy costs and non-energy costs has persisted and even widened in recent months may therefore be a sign of a slowing economy.
Here is the picture to which Kash is reacting:
But here is the picture from a slightly longer perspective:
In general, there is not loads of pass-through from the prices of finished energy goods at the producer level to non-energy finished goods. To be fair to Kash, the scale in the picture above makes it a little difficult to pick out any subtleties in the data, so here is a graph of the difference between PPI energy inflation and PPI non-energy inflation:
It is true that the there has recently been a bit more of a protracted drift in the spread between energy and non-energy inflation than has typically been the case in the past -- excepting the recession, this pattern appears to have held since 1999. But I don't see a very compelling case that this particular statistic has very reliable indicator properties for the pace of economic growth.
On the other hand, retail sales in December were generally considered "not so hot", to quote Barry Ritholtz. (The Skeptical Speculator adds, "US retail sales disappointed.") So, who knows? Maybe Kash is on to something.