Inflation is a very loaded term for economists, with plenty of debate around exactly what causes it and the best way to define it. But when most people hear the word “inflation”, they think about rising prices.
Understanding what’s happening to prices is very important. Measuring price inflation can help us to spot where potential problems might be building up in the economy. For example, rising prices might indicate shortages or bottlenecks. Falling prices might imply a collapse in demand. However, even then, getting a proper view on what’s happening to inflation depends on exactly which set of prices you are trying to measure.
Two of the most important such indicators for the economy are “producer price inflation” and “consumer price inflation”. So what are they and what do they measure?
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“Producer price inflation” is all about prices at the manufacturing level. It covers changes in the cost of raw materials used by producers of goods. And it also looks at changes in the prices of the goods produced. In other words, it looks at changes in manufacturer’s input costs, and also in what they charge for the finished goods when they leave the factory. This is why it’s sometimes referred to as “pipeline inflation” – it’s a measure of price changes that are currently further up the supply chain from the consumer.
“Consumer price inflation” on the other hand, looks at changes in the price of a basket of goods consumed by the average household. So for example, the producer price indexes would cover what it costs to make a jacket, and the price at which the manufacturer then sold it to a supermarket. Consumer price inflation would cover the price the supermarket charged customers for the jacket.
Most of the time, the key question is whether rising costs will end up being passed on to consumers or not. If so, then that will create inflationary pressure in the wider economy. But if producers and shops can’t pass on their higher costs – usually because there is too much competition in the market – then their profit margins will feel the squeeze, which can be bad news for investors in the companies affected.
To find out more about inflation and what causes it, subscribe to MoneyWeek magazine.
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