Gauging Inflation Pressures in the Economy

1
Gauging Inflation Pressures in the Economy

• An Overview

2
Read the supplementary notes for Topic 2

• Supplementary Notes on Inflation Analysis

3
Driving forces behind price changes

• Prices are related to production costs as
  follows
• P ?/Q w/APL iK/Q PEMEM/Q
• All else being equal, there will be upward
  pressures on prices if companies have
• (1) greater pricing power to maintain or expand
  profit margins (?/Q ?),
• (2) higher unit labor costs (w/APL ?),
• (3) higher costs of capital (i ?), or
• (4) rising energy and materials prices (PEM ?).

4
Determining factors for profit changes

• Profits are shown to depend on the following
  relationship
• ? Q(P w/APL) iK PEMEM
• All else being equal, profits can go up even
  without raising prices if companies can
• (1) produce and sell more (Q ?),
• (2) cut unit labor costs (w/APL ?),
• (3) reduce costs of capital (i ?), or
• (4) have lower energy and materials prices (PEM
  ?).

5
Building up of inflation pressures Stage 1

• Cost conditions
• (1a) Unit labor costs
• Wages ? ? Unit labor costs ?
• Labor productivity growth ? ? Unit labor costs
  ?
• (1b) Energy raw materials costs
• Oil prices ? ? Energy and materials costs ?
• Other basic commodity prices ? ? materials
  costs ?
• (1c) Capital costs
• Interest rates ? ? Costs of capital ?

6
Building up of inflation pressures Stage 2

• Pricing Power
• (2a) Foreign Competition
• Prices of imported goods ? ? Pricing power ?
• (2b) Demand Conditions
• General demand and spending ? ? Pricing power ?

7
Building up of inflation pressures Stage 3

• Price inflation at the producer level
• (3a) Producer price index (PPI) ? ? Inflation
  observed at the wholesale level

8
Building up of inflation pressures Stage 4
(Final)

• Price inflation at the consumer level
• (4a) Consumer price index (CPI) ? ? Inflation
  observed at the retail level
• (4b) Personal consumption expenditure price
  index (PCEPI) ?
• ? General inflation observed among consumer
  prices

9
An overall picture