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Review of scope and purpose of the producers price index

This article outlines our decisions from a review of the scope and purpose of the producers price index (PPI).

The PPI measures the average change in the price of goods and services, either as they leave the place of production or as they enter the production process. Therefore, the PPI is constructed as either output indexes, measuring the average change in the prices producers receive for their outputs; or input indexes, measuring the average change in the prices producers pay for their inputs.

In 2013 we reviewed the scope and purpose of the PPI. The review began with a report, which proposed confirming the current purpose of the PPI – to measure producer output and input inflation within the framework of the System of National Accounts. The report also presented related topics on which we wanted to better understand customer needs.

We discussed the report with customers and stakeholders and have now decided on the changes we are making. These are outlined below.

Summary of decisions we’re implementing

In our review we outline 17 decisions – 11 confirm our current practice, and six involve change. The six changes are:

Decision 6 – publish an analytical PPI series for all industries, excluding ownership of occupied dwellings. This series will give customers a market-only view of the PPI (excluding the notional output of owner-occupied dwellings).

Decision 7 – include financial intermediation services indirectly measured (FISIM) in the PPI input indexes. This change is consistent with how FISIM is treated in the national accounts following our implementing the System of National Accounts 2008.

Decision 14 – look into what would be required to produce stage-of-production or stage-of-processing indexes. A stage-of-processing index classifies goods or services according to their position in the chain of production (ie primary products, intermediate goods, or finished goods). A stage-of-production index allocates goods or services according to the stage in which they are used (ie a product is included in each stage to which it contributes, not just one stage). These indexes would provide an indicator of future inflation further down the production chain.

Decision 15 – publish an expanded range of commodity indexes, subject to confidentiality and fit-for-purpose quality.

Decision 16 – produce updated sources and methods documentation, including tables of industry and commodity weights. We will update these published weights tables annually following each PPI re-weight.

Decision 17 – investigate developing health and education output indexes as part of the commodity data collection / business price index rolling review. Currently we do not produce output indexes for these industries or public administration and safety.

More details on decisions we’re implementing

Decision 1: Purpose and use of the PPI

Primarily, the current PPI follows the System of National Accounts (SNA) concepts that underlie the production account. The PPI measures the average change in the price of goods and services, either as they leave the place of production, or as they enter the production process. Therefore, the PPI is constructed as either output indexes, measuring the average change in the prices producers receive for their outputs; or input indexes, measuring the average change in the prices producers pay for their inputs.

Uses for the PPI include deflating gross flows for calculating volumes in the national accounts, indexing commercial contracts, and as short-term indicators of producer inflationary trends. These diverse uses can have conflicting requirements in the types of indexes required, the weighting schemes used, the pricing level required, the types of transactions included, and the range of expenditure covered.

Decision: The principal purpose of the PPI will remain to measure producer output and input inflation within an SNA framework. This makes the PPI suitable for its key use, deflating gross flows for calculating volumes in the national accounts.  

Decision 2: Output and input indexes

We publish a comprehensive set of output indexes that cover all the New Zealand Standard Industrial Output Categories (NZSIOC), except public administration and safety (local government administration; central government administration, defence, and public safety), education and training, and health. The output PPI is used to deflate gross output for calculating volumes in the national accounts.

The published input indexes have the same level of coverage as the output indexes, except we also publish input indexes for public administration and safety, education and training, and health.

Decision: The purpose of the PPI is to measure producer output and input inflation within the SNA framework. Given this, the PPI will continue to be produced as output indexes similar to the SNA concept of gross output, and input indexes similar to the SNA concept of intermediate consumption.

Decision 3: Weighting concepts in the PPI

Currently, we produce the New Zealand output PPI using gross weights (done since inception in the 1970s), which means the values of all outputs within the same industrial classification category are in scope for weighting and pricing. This ensures the indexes are complete in covering the targeted industries. Consequently, we prefer gross weighting for deflating industry gross flows. This is done in national accounts using NZSIOC level 4 PPI indexes. However, when using gross weighted indexes, there can be multiple counting of price change as products flow through the different production processes – this occurs where the output of an enterprise is used as the input into another enterprise within the same PPI industry. The double counting of price movements makes the indexes less desirable for inflation monitoring.

Net weights are an alternative weighting method, where only the value of products sold to buyers outside the industry subdivision are included in the weight calculations.

A good example of the difference between the two methods occurs in the forestry and logging industry. Assume there is a forestry firm that grows and sells standing timber, and a firm that buys the standing timber, cuts it down, and sells the logs. An output PPI based on gross output weights would include the sale of the standing timber and the sale of the logs. However, an output PPI based on net output weights would only include the sale of the logs, plus any sale of standing timber to firms outside the industry concerned (ie outside the forestry and logging industry).

We also annually reweight our PPI industry and commodity weights, with the data generally sourced from the national accounts supply-use tables. We do make changes to the weights that are not consistent with the supply-use table when we have more up-to-date or better information. The weights associated with the commodities, and the weights attached to each industry, are therefore annually chain-linked. This reflects changes in economy-wide income and expenditure in the mix of products and the mix of industries.

Decision: We will continue using gross weighted indexes in the short term. In the medium term, if we develop stage of processing/production indexes these may provide measures more suitable for inflation monitoring (see decision 14).

Decision 4: Pricing basis for the PPI

In the New Zealand PPI, we use ‘basic prices’ collected directly from producers to compile the output indexes. The basic price is the price the goods or service producer actually receives from the purchaser of the goods or service, minus any taxes on products, separately invoiced transport charges, and wholesale retail margins, plus any subsidy received on that unit as a result of its production or sale. Sometimes we use producer's prices when the basic price is not readily available. The producer’s price is the basic price, plus any non-deductible tax on products paid by the producer, less any subsidies on products received by the producer.

Prices used in the input indexes are a mix of output proxy prices (at basic or producer's prices) and a few directly collected input prices (at purchaser's prices). Purchaser's prices exclude deductible taxes on products (eg GST), but include any non-deductible product taxes (if they exist) and any wholesale and retail trade margins or transportation charges. We use output proxy prices under the assumption that the trade and transport margins represent a constant proportion of the purchaser’s price over time, or that they are such a small proportion of the purchaser’s price that changes in the margin proportions are unlikely to have any substantial effect.

At Statistics NZ, we undertake rolling reviews of the PPI weights and prices, by industry, and also update lower-level commodity index weights and prices as required. Within these reviews, we closely scrutinise the pricing levels used in outputs and inputs, carefully targeting areas where pricing level is an issue, particularly for purchaser’s prices on the inputs side.

We ensure that our sources and methods information is transparent where the preferred pricing levels are, or are not, being used. Usually the output price (basic price) reasonably represents the purchaser’s price, where goods are used in a further stage of production, especially where producers deal directly with one another and no intermediaries are involved.

We also need to consider supplier load and are committed to demonstrating best practice for managing this across the Official Statistics System. Any increase in collecting additional purchaser's prices needs to be balanced by savings in other areas – ideally, there is no net increase in the number of prices surveyed. For example, as part of our ongoing rolling review of weights and prices, we review price collection – to eliminate prices that are no longer required.

Decision: The pricing level we use for output and input indexes will meet SNA requirements, where possible. Therefore, PPI output indexes will use basic prices and PPI input indexes will use purchaser's prices where necessary. This approach for the PPI inputs might include adding in a transport and trade margin where these are significant. This approach is also preferable for uses such as inflation monitoring and contract indexation.

Decision 5: Scope of transactions and transactors for output PPI indexes

Broadly speaking, the output PPI seeks to measure changes in the prices of goods and services that make up gross output (as defined by the SNA).

The PPI output indexes generally cover all market output of producers; that is, output sold at prices that are economically significant, or otherwise disposed of in the market, or intended for sale or disposal in the market. One exception is private health and education services, which are relatively small components within the government-dominated industries of health and education and are excluded from the scope of the current output PPI.

The PPI also includes some output for own final use, in the form of the notional output of the owner-occupied housing, which is a separately published industry. National accounts treats this output for own final use for owner-occupied housing as sales, and therefore we use this in the PPI output indexes. Other industries having output for own use are captured as services for own use in the supply-use system, which is not included in the PPI.

We also exclude other non-market activity. This consists of goods and individual or collective services, provided by non-profit institutions serving households or government, and that are provided free, or at prices that are not economically significant, to other institutional units or the community.

The International Monetary Fund's Producer Price Index manual of theory and practice supports the view that the PPI includes all market output and would also in theory cover output produced for own final use. In practice, output produced for own final use is difficult to obtain meaningful prices for.

Decision: Given that the purpose of the PPI is to measure producer price inflation within the framework established by the SNA, we will price only market transactions and market prices sourced from market producers, and also the ownership of owner-occupied dwellings, under output for own final use (to ensure coherence with the SNA).

Decision 6: Owner-occupied dwelling indexes

We publish the notional output of owner-occupied dwellings (OOD) as a separate industry in the PPI; it represents approximately 5 percent of the all industries (outputs) PPI. Prices for this industry are provided by CPI market rental prices. The production of housing services for their own final consumption by owner occupiers has always been included within the production boundary in national accounts.

Decision: We will continue to calculate the OOD index, for national accounts purposes, and include OOD in the all industries output and input PPIs. We will also publish the following new analytical indexes (with new identifiers) to provide customers with a market-only view of the PPI:

  • output PPI for industry group LL: rental, hiring, and real estate services excluding OOD
  • output PPI all industries excluding OOD
  • input PPI for LL: rental, hiring, and real estate services excluding OOD
  • input PPI all industries excluding OOD
  • input PPI all industries excluding admin, health, education, and OOD

We will implement this change from the March 2015 quarter (as part of our annual PPI reweight) and backcast these new indexes to the December 2010 quarter, when we implemented ANZSIC06.

Decision 7: FISIM in the input indexes (following 2008SNA)

FISIM is the general intermediation service provided by banks (and other financial intermediaries), which is not explicitly charged for but is implicitly charged for – through financial institutions lending money at higher interest rates than they pay to depositors (or organisations from which they borrow the funds).

Currently we include FISIM only in the output PPI index for the finance industry, which matched the national accounts treatment until the recent change to align with 2008SNA. Under the latest SNA, the PPI input indexes would include a FISIM component for each industry.

We treat interest differently in the farm expenses price index (FEPI) and the CPI. In FEPI, interest is measured using nominal interest rates and the weight reflects the total amount of interest paid by farmers. We have not included interest in the CPI since 1999, because the index uses an acquisition framework. However, there is an analytical CPI series that does include interest – interest is measured in the same way as for FEPI.

We plan to develop additional CPI analytical price indexes for particular groups of households over the next 18 months; these will use a payment framework and include interest. The interest measure will be based on gross interest rates and may also incorporate change in the prices of assets, goods, and services.

Decision: We will include FISIM in our input indexes from the March 2015 quarter. The current pricing measure for FISIM in the output indexes is suitable to use in the PPI inputs index, and moves in line with the price element implicitly derived from the national accounts series. We will be reviewing this price when we review the finance industry (to be done soon). This decision means the PPI will be consistent with 2008SNA.

Decision 8: Treatment of insurance in the PPI

Currently in the PPI we use the insurance service charge to weight insurance, not gross premiums. The insurance service charge is insurance premiums less claims. The PPI indexes we currently publish are fit for national accounts purpose, for insurance weights (under SNA the service charge approach is recommended), and we need to continue this in future. The CPI also uses a service charge approach for insurance weighting. We confirmed using service charge insurance weights for the recently re-developed FEPI indexes.

For practical reasons we price gross insurance premiums, although ideally we would price the service charge. However, pricing the service charge is technically challenging, and not common practice internationally.

Decision: We will continue to calculate the PPI using the service charge for weighting insurance, and we will continue to price the gross premiums.

Decision 9: Retail and wholesale industries

The wholesale trade and retail trade industries are the distribution industries. Their output is providing a distribution service. The margin (rather than the price) is how this service is charged, because wholesalers and retailers essentially buy goods from one agent in the economy and sell them to a different agent. They do not materially transform the goods they buy and sell through any production process. Therefore, we do not treat their activities as output, except in the sense that their profits form a part of value added. Value added for the distribution industries is the margin on sales of goods (gross output) less their intermediate consumption. We do not include purchases for resale in intermediate consumption; we deduct them from sales in gross output. This is because the goods sold are not used up in production.

The PPI Manual recommends pricing retail and wholesale margins directly, to represent changes in the price of the output of retail and wholesale industries. In New Zealand’s PPI, we use changes in the selling prices of commodities as proxies for changes in margins in the output PPI indexes, for the distribution industries, instead of collecting margin prices directly. This treatment assumes that margins represent a constant proportion of the sellers’ prices over time. Therefore when the price of the goods sold by the distribution industry rises, we implicitly assume the price of the distribution service rises by the same percentage. We have not directly price surveyed margins in the PPI because of the practical difficulties in doing this.

This treatment currently aligns with the way constant-price output is calculated for the retail and wholesale industries in the national accounts. We do not require a true margins deflator for national accounts as margins are not deflated directly. To calculate the constant-price output of a retailer (and wholesaler) in the national accounts, we multiply the base-year gross margin by the deflated values of sales – which requires a deflator of gross sales.

Decision: We will continue to use selling prices of commodities as proxies for margins in the output PPI indexes for the distribution industries; we will not attempt to price margins directly. This aligns with the method used to calculate constant-price output for these industries in the national accounts, where gross sales are deflated and margins are not deflated directly.

Decision 10: Extending PPI scope to cover more than national accounts gross output and intermediate consumption

It was suggested that we extend the scope of the PPI beyond the current SNA coverage. This is particularly on the inputs side where coverage relates to the SNA concept of intermediate consumption. Interest charges and local authority rates are examples of expenses suggested for inclusion in the input indexes. 

However, customers can currently use complementary series that cover capital (capital good price index) and labour costs (labour cost index), and weight these together with the input PPIs to get a more complete picture of changes in input costs.

Decision: The purpose of the PPI is to measure producer output and input inflation within the SNA framework. Given this, the scope of the PPI will not be expanded beyond the national accounts concepts of gross output (output indexes) and intermediate consumption (input indexes).

Decision 11: Frequency

In the International Monetary Fund’s General Data Dissemination Standards and Special Data Dissemination Standards, PPIs are a recommended output for national statistical offices. The former recommends a monthly PPI whereas the latter encourages a monthly PPI.

Decision: We will continue to publish the PPI on a quarterly frequency. Should the CPI change to a monthly publication in the future, this would not necessarily mean the PPI frequency had to change. A major use of the PPI is as deflators in the national accounts (gross domestic product), which is also published quarterly. Most of our other economic outputs are published quarterly.

Decision 12: Industry and commodity structure and detail

New Zealand’s PPI is constructed as a series of hierarchical indexes, working down from the all industries index to the lowest level of industry detail (NZSIOC Level 4 for calculation). NZSIOC is based on the Australian and New Zealand Standard Industrial Classification, which is in turn aligned with the International Standard Industrial Classification.

Underlying this industry hierarchy are ‘building block’ commodity indexes. At the most-detailed level are the ‘representative commodity’ indexes. These lower-level indexes feed up into the higher-level commodity indexes, which correspond with the commodity classification used in the national accounts (NA06CC), within the supply and use balancing system. NA06CC is a single-level five-digit classification with 297 categories; it concords to the international commodity classification, Central Product Classification.

We compile representative commodity indexes separately for domestic sales (outputs) and purchases (inputs), exports (outputs), and imports (inputs). We do this to separately identify export and import prices, which should only be used in output and input indexes, respectively. This has the benefit of allowing separate analysis of the effect of import prices on industry input prices. The same applies to export prices in the output indexes. Taking this approach aids our analysis of price movements in the aggregate data, and provides context for information releases. Such additional detail would also be useful in compiling constant-price supply-use tables.

Decision: We will continue producing the PPI using the NZSIOC industry and NA06CC commodity classifications, and use the building-block approach for compiling the PPI. This provides coherence with the national accounts supply-use tables and also gives us a flexible approach for maintaining the relevance of the indexes.

Decision 13: Index formulas

The Laspeyres is the most-commonly used index formula, both in New Zealand and internationally. We compile the PPI using a variation of this base-weighted formula.

We use the weighted price relatives’ form of the Laspeyres formula at all levels of the index calculation, from lower-level (elementary) aggregates to higher-level industry indexes. Where no information is available to weight priced items within lower-level aggregates, the items are equally weighted.

A base-weighted Laspeyres price index measures the changing cost over time of a fixed basket of goods and services. A PPI outputs index measures the revenue from selling, while a PPI inputs index measures the cost of purchasing such a basket of goods or services. Using this formula assumes, through fixed base weights, inelastic demand. That is, no quantity changes or product substitutions are made in response to relative price changes or changes in taste and fashion. This generally means the Laspeyres formula tends to overstate price change where there is substitution towards products with relatively lower price movements. We mitigate this tendency in the PPI through annual updates to the weights.

The PPI Manual does not definitively state what formula should be used for elementary aggregates. Several options are available and it does mention that if weights are available they should be used – we do this when weights are available. The Jevons formula is used in New Zealand’s CPI at the elementary aggregate level for categories of goods where substitution occurs; some of these indexes are used in the PPI as proxies for the retail trade industries.

Decision: The weighted price relatives form of the Laspeyres will continue to be the principal formula used to calculate lower-level aggregates and higher-level indexes in the PPI. We also plan to compile a retrospective Fisher index (which uses base and current weights), which will show the effect of commodity substitution within each year of the annually chained index, and a fixed-weight Laspeyres index that will show the effect if we had not done annual re-weights.

Decision 14: Stage-of-production/processing indexes

A stage-of-processing index classifies goods or services according to their position in the chain of production (ie primary products, intermediate goods, and finished goods). This framework allows analysts to track price inflation through the economy – for example, price changes in the primary stage could feed through into later stages, to indicate future inflation further down the production chain. We allocate a product to only one stage, even though it may occur in several stages.

A stage-of-production index allocates goods or services according to the stage in which they are used (a product is included in each stage to which it contributes, not just one stage). We classify products to the different stages by referring to input-output tables and, to avoid multiple counting, the stages are not aggregated.

The United States publishes stage-of-processing indexes as their headline PPI measure, and Australia produces stage-of-production indexes as their headline measure along with a limited range of industry indexes.

Decision: We will look into:

  • the differences between stage-of-production and stage-of-processing indexes to assess which would best suit our customer needs
  • what would be required to develop and produce these indexes.

We will decide when this work will be done by June 2015.

From this future work we will have a good understanding of the data gaps and resources required to produce these indexes, which will help us assess the priority of producing these indexes relative to other possible initiatives.

Decision 15: Publish more commodity indexes

We currently publish 19 selected commodity indexes, which were decided on in the 1990s and reviewed when we implemented ANZSIC06 in 2010.

We have approximately 300 high-level commodities in the PPI, one set for outputs (which feed into the output PPI industry indexes) and one set for inputs (which feed into the input PPI indexes). The main difference is that the output commodities could include export prices (as they represent products and services that companies sell, and could therefore export), and input commodities could include import prices (they represent products and services that companies buy, and could therefore import). The output commodities should contain prices measured at basic/producer’s prices (the price the producer receives for goods), while the input commodities should be priced in purchaser’s prices (the price a producer pays for goods).

Petrol offers a real example of these prices in the PPI. The output commodity for petrol collects the basic price for petrol that the manufacturing companies receive (excludes excise tax and any delivery charges). These prices make up a significant part of the output of the petroleum manufacturing industry. The input commodity for petrol collects a combination of petrol retail prices and bulk user prices (both include excise taxes and delivery charges (purchaser’s prices). These prices make up a small amount of the inputs into all industries. Note that the petrol retail outlets (if a separate company to the manufacturer) get income from the margin they make on the petrol; in the supply and use system they do not supply or use the petrol commodity.

In reality, we mostly collect prices in basic/producer’s prices – the additional supplier load to get all prices in basic/producer’s and also in purchaser’s prices would outweigh the benefit of having two pricing points. We do have examples of collecting two different pricing points for the same product (eg petrol).

Decision: We will publish as many commodity indexes as possible, subject to confidentiality and fit-for-purpose quality. We will publish the most-important commodities in the PPI information release tables, and the remainder on Infoshare or NZ.Stat.

We will publish both the output and input commodities, where relevant, and with this, information about the differences between the two commodity series. We will begin to publish these commodities in the June 2015 quarter PPI release.

Decision 16: Update sources and methods with weights table

The current sources and methods information for the PPI is out-of-date (from the 1990s) and customers expressed the need for an updated version. They would also like us to publish more information about our indexes, in particular what makes them up (commodities and weights) and how we go about pricing specific goods and services. This can all be covered in an updated sources and methods document, which would also include the weights. Better information about our indexes will mean our customers can use our indexes with greater confidence.

Decision: We will have an updated sources and methods document publicly available in 2015. With resource constraints, we can produce the updated text for some industries (the industries we recently redeveloped), and all the industry-by-commodity weight tables (which will be updated annually with the PPI re-weight). For the remaining industries, we will update the sources and methods text as we finish redeveloping each industry.

Decision 17: Health and education output indexes

We currently publish only input indexes for health, education, and government industries.

Developing output indexes from scratch is quite time consuming – we would need to collect commodity weighting information, and review prices we currently collect to see if they are sufficient for the PPI. We would price only market transactions for these industries (see decision 2).

Decision: We will develop output indexes for health, and for education and training, if feasible when we review these industries as part of the commodity data collection/business price index rolling review (currently scheduled for 2019 – although this work can be brought forward if it becomes a higher priority). We will review the work needed to develop these indexes and consult customers about their specific needs.

Note: if we do publish output indexes for the health and education industries, there would still not be a full suite of output indexes. We would not include the government industries because they have very little market output we could collect price information on.

Summary

Of the 17 decisions outlined above, six involve change. We will start implementing the changes from the March 2015 quarter.

  • Decisions 6 and 7 (owner-occupied dwellings, and FISIM in the input indexes) will be implemented in the March 2015 quarter PPI release as part of the annual re-weight.
  • Planning for decision 14 (looking into stage-of-production/processing indexes) will finish by June 2015.
  • Decision 15 (publishing more commodity indexes) will start to be implemented from the June 2015 quarter. We will stagger the publication of new commodities from this date onwards.
  • Decision 16 (updated sources and methods with weights table) will be implemented from 2015 onwards, beginning with industry-by-weight tables and some updated text.
  • Decision 17 (health and education output indexes) will be implemented (if feasible) when we complete a review of the health and education industries, which is currently scheduled for 2019.

We thank everyone who provided feedback on the original report.

For more information on the decisions, please contact James Griffin on (04) 931 4600 or email info@stats.govt.nz.

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