PPI Hedonic Adjustments
With CPI coming out at 8:30 this morning, I wanted to take a few moments to note some of the oddities and aberrations in the Producer Price Index (PPI).
A nagging thought about PPI: It is like a ratchet wrench, one that can only torque in a single direction. When we have Energy price spikes, there's seems to be no impact on producer prices; yet when Energy prices come down, we see a huge drop. One would imagine these things were somewhat symmetrical (but apparently, not). Something doesn't compute.
Consider this quandry: How is it possible that prices throughout the entire pipeline, from raw materials to finished goods, managed to stay tame no matter how high energy prices went during the past 3 years? The riddle is answered by observing that government models are gamed to show as little inflation as possible; Otherwise, the COLA obligations would be going through the roof.
Bill King (of The King Report) makes a similar observation: "Isn’t it interesting that PPI didn’t surge when oil did, but when oil declines sharply PPI plunges?"
Consider his observations on the BLS PPI data:
“Prices for light motor trucks fell 9.7 percent following a 3.5-percent gain in the preceding month. From October 2005 to October 2006, the index for light motor trucks dropped 12.4 percent…In accordance with usual practice, most new-model-year passenger cars and light motor trucks were introduced into the PPI in October. (See Report on Quality Changes for 2007 Model Vehicles, USDL 06-1973.)” Quality changes produce hedonic adjustments to prices. Ergo the large drop in vehicle prices is fiction. It’s the work of BLS bureaucrats, the Winston Smiths from “1984”.
The ‘quality’ or hedonic adjustment to light vehicles is $392.10/vehicle. The BLS reduced the actual costs of these vehicles by $392.10 ERV. For autos the BLS adjusted the real price $139.96 lower. So as we have maintained for years, PPI and especially CPI are constructed so that they can’t show actual inflationary changes or pressure." (emphasis added)
So the anti-inflation question at hand is simply this: Did real prices fall, or was this function of statistical sleight of hand? You may recall the headlines for October Retail Sales noted the role of autos and light trucks: Autos Save Retail Sales From Sharp Decline.
Let's take a closer look at PPI and Oil (continuous futures contract) again, courtesy of Bill King:
"Economist Bob Brusca on CNBC yesterday noted that the PPI report has light vehicle prices down almost 10%. Brusca added that no one believes this is reality. He added that the index has ‘a problem’ because we have a strong labor market with wage inflation.
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The ridiculous PPI reading induced buying of bonds and selling of stocks."
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And today, we get CPI. At least we are never wanting for riddles to unravel . . .
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UPDATE November 16, 2006, 10:23am
BLS inflation reporting is what it is. We can take it at face value, or try to figure out what is really going on.
As noted above, I have a problem with the entire "Inflation Ratchet." If its not inflation when energy prices are rising, how can it be proof that inflation pressures are easing when energy comes down? That's inconsistent.
Look no further than today's CPI for an example: Apparel was called down 0.7% in CPI, along with the following explanatory BLS note: "Prior to seasonal adjustment, apparel prices rose 1.3%, reflecting the continued introduction of fall-winter wear."
Look at Hotels also, down 0.5%. BLS explanation? “Prior to seasonal adjustment, the index for lodging away from home increased 0.5 percent.”
All Items less food and energy was up but 0.1% on a monthly seasonally adjusted basis. Year-over-year comparisons, however don't get "adjusted. All Items (ex food and energy) were up 2.6% from October 2005. That's EX food and energy.
So you can look at the hedonically altered, seasonally adjusted, inflation ex inflation headline spin -- or you can look at reality.
If identifying the data before it gets tortured is "zealotry," then so be it. . .
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Sources:
ADVANCE MONTHLY SALES FOR RETAIL TRADE
Census Bureau, Service Sector Statistics Division
TUESDAY, NOVEMBER 14, 2006, AT 8:30 A.M.
http://www.census.gov/svsd/www/marts_current.html
CONSUMER PRICE INDEX: OCTOBER 2006
Consumer Price Index Summary
U.S. Bureau of Labor Statistics, Division of Consumer Prices and Price Indexes
http://www.bls.gov/news.release/cpi.nr0.htm
Thursday, November 16, 2006 | 06:18 AM | Permalink
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Comments
Maybe there ought to some way to reduce the "quality" of our paper cuurency to offset the increase in "quality" of vehicles!
Posted by: Uncle Bob | Nov 16, 2006 8:00:36 AM
It blows me away that the Fed still maintains credibility. We'll certainly get a soft landing, on paper anyway.
Posted by: Mike M | Nov 16, 2006 8:16:48 AM
I see two possible explanations for this discrepancy (the magnitude of PPI drop cannot be explained by the drop in oil prices alone; there should be other factors):
1. Our government manipulates the data (less likely but possible).
2. We are already in a recession (very much likely, considering that two major sectors of the economy like housing and auto have been already in a recession).
Posted by: V L | Nov 16, 2006 8:21:05 AM
V L, if you are interesting in learning more about how the gov't has 'adjusted' its methodology for calculating jobs, inflation, and other econ data, you might want to check out 1) Kathryn Welling's interview with John Williams @ Shadow Stats (just Google it) or 2) John Williams' Shadow Stats website. Both are excellent reads.
Posted by: Vega | Nov 16, 2006 8:37:37 AM
A single digit VIX today?
Posted by: James Bednar | Nov 16, 2006 9:01:11 AM
wunderbar! from germany
i have the right cartoons to the efforts to keep inflation down
http://immobilienblasen.blogspot.com/2006/11/enron-acounting-to-keep-inflation-low.html
Posted by: jmf | Nov 16, 2006 9:07:04 AM
BR: Normally you are a smart, interesting guy. But your now a zealot on inflation. It seems you don't pay attention to good counter-arguments.
I happen to be in the opposite camp and I do not think you are making quality adjustments in any of your price assessments. "Inflation" is about prices increasing for the SAME goods - i.e. a purely monetary phenomenon. It seems that everything I buy today -- car, Ipod, TV, mobile-blackberry-service, HD cable, JetBlue flight, organic hormone-free beef, Starbux latte, etc, etc, etc... Everything, when you consider the quality, service, availability, and experience (all part of the product) are LESS then they were 5, 10, 15 years ago.
What would TODAYS Toyota Camry have cost in 1990? I want side-curtain airbags, leather interior, anti-locks brakes, GPS nav system, satelite radio, and the reliability. It would cost MORE.
Yes, home prices have gone up -- but have you seen the kitchens and bathrooms? Who had multi-head showers in 1990? Marble counters? Stainless steel appliances?
What would todays computer, TV, healthcare, education, boutique hotels, etc, etc... have cost in 1990 if they were the SAME!
So, yes, I agree there is alot of money out there. And there is no denying the prices of basic commodities have gone up. But the fundamental use of MORE wealth is not to buy MORE gruel, MORE cars, and so on -- but to buy better QUALITY.
Any assessment of inflation must be focused on trying to quality adjust consumption baskets.
Posted by: MJ | Nov 16, 2006 9:16:51 AM
jmf: Inflation is more than cars, latte and electronic gadgets.
Every trip to the grocery store, I see increases on at least one item. The gasoline I bought in 1990 was ~$1.00 per gallon. The house I bought in 1991 costs more than double today. Natural gas bill last winter was nearly double, even with a new, more efficient furnace.
If you fall into the trap of gubmint stats and exclude food, energy and housing (buy, not rent) then everything ig great. But WHO can live without food, energy and a house??
Posted by: 4merRepublican | Nov 16, 2006 9:33:39 AM
Interestingly enough.... BR has stepped up the PR campaign. I'm betting that we are close to a top......
When the bears come out of hiding they are usually getting ready to strike. There is no doubt there is excess bullishness right now, and there will be lots of profit taking.....
Posted by: Andrew | Nov 16, 2006 9:37:21 AM
hi 4mer reb,
was the response to me?
Posted by: jmf | Nov 16, 2006 9:50:21 AM
BLS inflation reporting is what it is.
If identifying reality is "zealotry" then so be it
Posted by: Barry Ritholtz | Nov 16, 2006 10:07:52 AM
There is nothing wrong with hedonic pricing.
An 80GB hard drive is not the same thing as a 40GB hard drive, no matter how much tin foil you put around your head.
Posted by: blaze@blaze.com | Nov 16, 2006 10:56:33 AM
That being said, I'd sure as hell wish that land prices could work their way into CPI.
Posted by: blaze@blaze.com | Nov 16, 2006 10:57:40 AM
mj: But that argument only make sense if spending is primarily discretionary. I liked the 1990 Camry and I'd love to buy another one, especially at a price that discounts 16 years of improvements. Unfortunately, I can't and if I need a new car (i.e, a transportation device) I have to pay the asking price - and it's higher than it was.
Posted by: cButler | Nov 16, 2006 11:00:59 AM
I've been reading this blog for almost a year now, and I have to say, this is becoming more of a conspiracy blog than a financial one.
I can accept that fact, but let's all be clear about what's being disseminated here, both by the author as well as the commenters...pure speculation, massive conspiracy theories, etc. I think that if this keeps up, Barry himself will lose legitimacy.
We can all agree that the housing market sucks, that the twin deficits are scary, that outsourcing takes its toll, etc., but what we're talking about lately has gone far beyond that.
Posted by: Eddie | Nov 16, 2006 11:02:04 AM
Once again.......
Personal attacks reveal a weak or non-existent argument.
First, Barry is ASKING more than he is stating.
Second, if you can't answer the question yourself, then please refrain from personally attacking those who can or YOU are clearly risking looking the Alcoa Hat King.
It isn't conspiracy theory to ask where this rather sizeable discrepancy/imbalance comes from.
It's kinda important to seeing where the economy REALLY is instead of where that ring in your nose takes you........
Posted by: Craig | Nov 16, 2006 11:17:48 AM
Just to be clear, I agree that inflation is understated and that hedonic adjustment is a satanic art. However, you dismiss the ratcheting effect too quickly. Industries are constantly adjusting to higher input costs of all kinds, and when they make structural adjustments--such as retooling plants to use less energy--they damp costs on price upswings and reap the benefit on the downswings. The time scale is important here and may be immaterial to the latest PPI, but I'm afraid your ideological zeal is causing you to overgeneralize.
Posted by: John F. | Nov 16, 2006 11:33:08 AM
WHY DOESN"T GOLD OR A LOWER US DOLLAR REFLECT THIS "NON-SENSICAL" INFLATION DATA?
HOW ABOUT ASSET PRICES LIKE STOCKS AND REAL ESTATE, MAYBE EVEN BONDS. THEY HAVE BEEN UP LIKE CRAZY, DON' THEY FIGURE INTO INFLATION NUMBERS?
IF NOT, WHY?
Posted by: Ricardo | Nov 16, 2006 11:33:14 AM
the BLS also keeps down the weights of components that go up in price so they don't exert a larger influence on the PPI or CPI. an example of this is this is the category for education and communication. even though the cost of tuition and books now far exceeds the cost of computing and phone service, the latter still has a weight that's nearly 50 percent higher than that for education. granted that most people don't have to pay for their kid's college every year, but that cost should be incorporated into most families' budgets each year as if a portion of the cost were being set aside to be paid out in the future.
Posted by: Les | Nov 16, 2006 11:38:31 AM
Eddie,
It appears there are other components (in addition to drop in oil prices) responsible for the decline and we are trying to figure it out.
For example, apparel was down -0.7% and Wal-Mart cannot keep up with cutting prices? Why? Why folks are not buying? They should have more cash according to Wall Street cheerleaders. Why?
What is your explanation as to why when oil prices were spiking the government inflation numbers had only a modest increase but when oil prices retreated (note that oil prices are still very high as compared to a couple of years ago) the inflation is in free fall (according to government estimates).
If you look at the graph above you can see that the last time we had such a sharp drop in inflation was during a recession.
Posted by: V L | Nov 16, 2006 11:47:24 AM
I formerly worked at a Federal Reserve Bank as a research analyst for two economists. Many times there was discussion of what measures of inflation were most suitable.
There was consensus among many of the economists that the common inflation measures (CPI, PPI, even PCE) were not the best measures of core inflation - for many of the reasons stated above.
I recall two alternate measures that were discussed:
(1) Trimmed Mean PCE
(2) Median CPI
I'm not suggesting that these measures are by any means perfect - as I remember discussions of their methodology and limitations - but they do provide alternative measures of core inflation beyond simply ex-food/energy.
Barry, I (and I'm sure others) would be interested in your take on these measures, as some have previously asked you to suggest better measures of inflation.
Thanks!
Posted by: bodanker | Nov 16, 2006 12:02:17 PM
Eddie: Your conspiracy statement is tantmount to looking at the BLS data in a vacuum, closing your eyes, covering your ears and yelling "Blah blah blah." The hedonic adjustments are fact, not conspiracy. They are all there in the fine print at the BLS site. Every crroked tactic they use is documented in the fine print. Open your eyes and read the fine print before writing it off as conspiracy theory.
Posted by: 4merRepublican | Nov 16, 2006 12:05:34 PM
If you want a real conspiracy theory, ask how or why the Philly Fed survey was leaked (to the decimal point) 5-10 minutes early for the second month in a row.
Posted by: Macro Man | Nov 16, 2006 12:17:44 PM
I am an average middle class worker and whenever i go to the store for groceries, out to eat, clothes stores etc, I see prices rising all over not falling. Sales are posted but the sales arent like they were and in many cases the new listed sales price is higher then just a few months back. Its absurd that the BLS adjusts prices as noted, all they have done is produce headline numbers whether its Employment or Inflation that keeps foreigners buying our debt. And maybe thats the goal here, because if any of these foreigners in China, Japan etc asked the middle class of america about inflation they woul d get the true story and start selling their US assest. Which in turn would be bad for the country, what I am seeing now is with the premature rally in the bond market, based on the fact that housing is about to fall off a cliff is acutally having the opposite effect. Housing is picking up again as rates stay low, no not booming but picking up which means the cliff fall will not happen as long as they act like the fed is cutting rates tommorow. I live in Bubble central in California, when the bond market gets a clue and yields rise the market will slow and eventually pop i dont think it has, i see that as a year from now. Then i think the fed starts cutting.
Posted by: Hockeyman77 | Nov 16, 2006 12:25:47 PM
News crossing the wires: Milton Friedman has died.
Posted by: Mr. Beach | Nov 16, 2006 12:30:22 PM
