How much more expensive did products, services, and construction get? That’s what the Producer Price Indexes (PPI) tell you.

For example, in the US report for October 2022 the “Producer Price Index for final demand increased 0.2 percent”. That means prices went up month over month. You can compare that to the previous month or the year before and look at the trend.

When that trend turns downwards, when prices slow down or even fall, that’s usually a sign the economy isn’t doing great. That’s how you can use the PPI as a recession indicator.

But which prices went up 0.2% and what does “final demand” mean? Why “indexes”—are there multiple? And how is the PPI different from the Consumer Price Index (CPI)?

Excellent questions—we’ll discuss them below, and also have a look at how the Producer Price Index (PPI) holds up as a recession indicator.

warehouse with tires, two yellow forklifts at work

Source: mm-logistik.vogel.de, CC0

In short

  • PPI: How did prices for domestically produced things, services, and construction change?
  • Producers lower prices only when they reaaaally must. That means PPI is behind the trend—it’s a lagging indicator.
  • There are many PPI, per industry or commodity. Some of them munched together—the “final demand” ones—make up the PPI number you see in headlines.
  • CPI is different. Yep, it also measures price inflation, but not the same way as PPI. CPI focuses on what people typically need—PPI on everything that is being produced.

What is the Producer Price Index (PPI)—or indexes?

The PPI is a series of numbers put together usually by some government agency. It shows how prices have changed compared to the previous time the PPI was put together.

What prices are we talking about? Generally, it’s about prices that domestic companies charge for products and services.

Importantly, the PPI is not just looking at retail: in fact, in the US until 1978, the PPI was called “Wholesale Price Index”.

It all starts with collecting data. Here are a few examples from the US data series by industry, commodity and a few services:

  • “Raw bituminous coal and lignite from surface operations, for use without processing”
  • “Parts & accessories for turbines, turbine generators, and turbine generator sets”

How about data for juicy commodities?

  • “Milled rice (incl second heads, screenings, brewers, bran, sharps, rice flour, and byproducts)”
  • “Secondary copper, alloyed and unalloyed” (probably a confusing time to mention that copper prices are also a recession indicator, so I won’t)

Still here? Amazing you! How about some services?

On all that and much more someone collected data on how prices changed. Check out the lists here.

So, you get the idea. Looooots of data is collected, and then it’s munched together. Depending on how much you munch together, you end up with a PPI for “dental care” or something as broad as “Final demand foods”.

For the US, the headline figure is the aggregate of the PPIs for “final demand”.

What’s final demand again? It measures the price changes for commodities that are sold for personal consumption, capital investment, government, and export.

Why the PPI matters (it's a gauge for the economy)

Mind-blowing all this, I know, but why would you care?

First, it’s an indicator for inflation to come. Whatever you produce or service you delieve, you need something to do so. Raw materials labor, energy or whatnot. If the prices for those things increase then at some point you’ll have to pass that cost on. And you can see these “price waves“ ripple through the various PPIs. If enough of them come together, you’ll have to end up with higher consumer prices at some point.

The other reason has to do when the trend reverses. If producers cut prices then they’re doing it for a reason. Maybe because prices of raw materials have sunk—or maybe they need to give discounts because there is less demand for what they produce. And if that happens across the board, then you know something really is afoot. That’s why the PPI is used as a recession indicator.

Does PPI work as a recession indicator?

To figure out if PPI is actually useful, let’s compare it to economic output as measured by GDP. As imperfect as both numbers are, they should be correlated.

In the following graph you’ll see two lines, blue for headline PPI, red for nominal GDP. (Look at the latest one here.) You’ll notice that both lines roughly follow the same trend.

Two lines, blue for PPI, red for GDP. PPI line is generally below the GDP one and roughly follows it

Sources:

U.S. Bureau of Labor Statistics, Producer Price Index by Commodity: Final Demand [PPIFIS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/PPIFIS, November 26, 2022.

U.S. Bureau of Economic Analysis, Gross Domestic Product [GDP], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GDP, November 26, 2022.

You’ll also notice that PPI dipped in the 2020 recession, when GDP plunged massively. Which brings us to the next question.

Does PPI predict a recession? (Is it a leading or lagging indicator?)

Looking at the Producer Price Index, can you see a recession coming? A look at the graph above confirms what people say: the PPI is behind the economic curve. It might tell you: yup, you are currently in downturn—but it doesn’t help you much see one coming.

But you already this: how often do you see prices actually go down? Usually, prices only ever seem to know one direction: up. In other words, producers must be in a really bad situation so that prices actually go down. (Economists say that prices are “sticky”.)

Typical headlines

Here are articles linking the PPI to recessions:

Where to find the data?