CHAPTER 2 – PRINCIPAL PURPOSE OF THE PRODUCER AND INTERNATIONAL TRADE PRICE INDEXES
BACKGROUND
2.1 Producer Price Indexes (PPI) are indexes designed to measure the average price change of products (goods and services) either as they leave the place of production or as they enter the production process. PPIs fall into two categories and are either input price indexes or output price indexes.
2.2 Input prices are valued at purchasers' prices, which are defined as the amounts paid by the purchaser. They measure the average price change of intermediate inputs used in production by a specified industry of the economy. Intermediate inputs are either inputs into a production process elsewhere in the domestic economy, or are imported. An ABS example of an input price index is the price index of materials used in manufacturing industries (MUMI). Please see Appendix 1 for a discussion of valuation bases.
2.3 Output prices are valued at basic prices, which are the amounts received by the producer. They measure the average price change of produced goods and services that are sold on the domestic and export markets. An ABS example of an output price index is the price index of articles produced by the manufacturing industries (APMI).
2.4 Import and export prices are important extensions of domestic PPIs. The Australian International Trade Price Indexes (ITPIs) measure the average change in the prices paid for imports of products that are landed in Australia and the average change in the prices received for exports of products that are shipped from Australia. Both the import price index (IPI) and the export price index (EPI) are valued using a free on board (f.o.b.) pricing basis.
2.5 An industrial classification is one way to organise production unit data. It provides a standard framework under which business units carrying out similar productive activities can be grouped, with each resultant group referred to as an industry. For the PPIs and ITPIs, products are assigned to the Australian and New Zealand Industrial Classification 2006 (ANZSIC06) on the basis of their being primary to a particular industry (output indexes) or used by production units classified to particular industries (input indexes). The categories within ANZSIC06 are, division, subdivision, group and class.
2.6 While the PPIs and ITPIs should cover all products within the Australian National Accounts (ANA) and Balance of Payments (BOP), they are currently based only on a subset of products (those primary to an industry) and do not represent the entire activity of production units classified to a particular industry. The PPIs and ITPIs produced by the ABS also cover a broader range of goods than services. This coverage imbalance is due to the relatively recent rise in the importance of services to the Australian economy and the inherent difficulty in measuring pricing change in services.
2.7 The prices of products do not all change at the same rate. Because price change can vary considerably from product to product, the level of the price index will depend on the products selected and their price behaviour. The weights used to combine the prices of the individual products will also impact upon index behaviour. The source data for weighting the PPIs is from the Australian National Accounts Input-Output (I-O) tables, whereas the source for weighting the ITPIs is derived from International Merchandise Trade data. The current weighting basis for the IPI is derived from the average value of import items during 2009–10, while the EPI uses the average value of export items during 2008–09 and 2009–10, due to the greater volatility associated with the value of export items.
PURPOSES OF THE PPIs AND ITPIs
2.8 A key purpose for which the PPIs may be designed is as a deflator (or inflator) of the values of a number of components in the ANA and BOP, including industry inputs and outputs, sales, capital expenditure and inventories. The deflation process is integral to the compilation of chain volume estimates of Gross Domestic Product (GDP) and its components.
2.9 The principal purpose of the ITPIs is for deflating external trade values to provide indicators of the volume of international trade. Import prices feed into producer input indexes as these are an important contribution to producer costs. Similarly, export prices feed indirectly into producer output indexes as exports frequently represent a significant component of producer revenue.
2.10 GDP, the headline statistic of the ANA, and other key economic statistics are expressed in volume terms. Economic transactions are usually recorded as the value of the transaction. This value represents the volume of the product produced or consumed multiplied by the price per unit of volume. These are indistinguishable in the observed transaction value and need to be calculated. In economic statistics, volume measures are typically derived by dividing an observed transaction value by a price index.
2.11 There is broad agreement that the volume component is made up of the number of units and the quality change in the product. If the number of consumed units in the period is known, the value of units consumed can be divided by this number to calculate a price per unit. However, if data from two periods are compared and a unit in one period is of a higher quality than a unit in the other period, the higher quality unit should be reflected as a higher volume.
2.12 In order to calculate the desired volume measure which includes any quality change, quality change must be excluded from the price index used. The change in price represented by the index is not always the observed change in price of the unit. If the quality of the unit increased, the price index will show a change lower than the observed unit price change.
2.13 Pure price indexes adjusted for quality, such as the PPIs and ITPIs, are the type of indexes required to derive the volumes measures of, for example, output (gross output of the economy) and intermediate consumption. The ABS gives priority to the use of PPIs and ITPIs in the ANA and BOP due to their importance in macroeconomic analysis.
2.14 Another purpose of the PPIs with the availability of detailed product and industry data is the monitoring of short term price inflation through the different stages of production. The main users of the PPIs for this purpose are the Reserve Bank of Australia (RBA) and federal and state treasury and finance departments. Government agencies (and many companies) require the indexes for macroeconomic forecasting as well as determining and assessing macroeconomic policy.
Other uses
2.15 Indexation of contracts is a procedure whereby contracts for the provision of products include an adjustment to the value of monetary amounts for the products, based on the increase or decrease in the level of a price index. The purpose of the indexation is to shift the inflationary risk from the contractor(s) to the project developer or owner. A PPI offers an independent indicator of the change in prices of the products under contract. The ABS neither endorses nor discourages such use.
2.16 Australia provides PPIs to the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD) for economic monitoring and comparison with other countries. A PPI is a required indicator for countries, such as Australia, who subscribe to the IMF Special Data Dissemination Standards (SDDS). The SDDS set out criteria to be met by countries concerning the statistics produced such as their periodicity and advance notification of release dates.
2.17 As the PPIs are released two days prior to the Consumer Price Index (CPI), the SOP indexes are used as a predictor of certain products within the CPI.
SCOPE OF THE PPIs
2.18 PPIs are affected by the choice of principal purpose and this choice determines the scope for the indexes. The scope of the PPIs determines the transactions to be included in the measure of price change.
2.19 The choice of scope approaches for the PPIs are:
- a gross industry approach; and
- a net industry approach.
2.20 Internationally, some national statistical offices are legislatively obliged to produce PPIs on both a gross and a net industry approach. The ABS notes that in some places the terms gross sector and net sector are used to represent gross industry and net industry. The ABS defines the term sector as per the the System of National Accounts 2008 (2008 SNA) that is, a grouping of units to form institutional sectors on the basis of their principal function, behaviour and objectives.
Gross industry approach
2.21 Conceptually, within gross industry indexes, transactions between production units classified to the same industrial classification category (such as a subdivision) are in-scope for index weighting and pricing. This ensures the indexes are complete in terms of coverage of the targeted industries, however as products flow through different production processes within the industry, transactions will be counted multiple times.
2.22 The following example illustrates the concept of the gross industry index. Within an index representing the outputs primary to the Food Product Manufacturing subdivision (ANZSIC06), sales of sugar to the cake and biscuit manufacturing industry are included. Production units producing sugar are classified to the same subdivision as those producing cakes and biscuits and the transactions represent intermediate usage within the Food Product Manufacturing subdivision. When the two activities are combined to produce an aggregate index, the importance of the first transaction is measured multiple times in the
index.
2.23 Gross industry indexes require one set of weights to construct the range of division, subdivision, group or class indexes. For example, a division level index can be derived by weighting together separate lower level indexes.
Net industry approach
2.24 PPIs may be constructed under a net industry approach, where any intra-industry transactions are netted out in a manner similar to the process used by accountants in consolidating a set of accounts for a group of enterprises. Net industry indexes exclude transactions made between production units classified to the same industrial classification category (such as a subdivision).
2.25 Conceptually, a net industry index avoids multiple counting of transaction prices as products flow through production processes. While conceptually valid, excluding the internal intermediate transactions from the net industry indexes results in incomplete coverage of the targeted industry.
2.26 The gross industry index example above can be modified to illustrate the concept of the net industry index. Within an index representing the outputs primary to the same Food Product Manufacturing subdivision, sales of sugar to the cake and biscuit manufacturing industry are excluded. Transactions that represent intermediate usage within the Food Product Manufacturing subdivision are netted out of the index. This avoids combining the two transactions within the
index.
2.27 In this example, the in-scope the transactions for the Food Product Manufacturing subdivision index are sales of sugar to:
- production units classified to industries other than Food Product Manufacturing; and
- final demand (e.g. final consumption or export).
2.28 Net industry measures cannot be aggregated. A division index cannot be derived by weighting together the separate subdivision and group indexes. Multiple weighting patterns are required to produce a range of independent net industry indexes.
Recent PPI scope change
2.29 Until the September quarter 2009, the Australian manufacturing industry PPIs used the net industry approach. Following the ANZSIC06 implementation in the September quarter 2009, the weighting bases were re-designed to provide greater coherence with ANA requirements, moving the PPI weighting structure from a net to a gross industry approach.
2.30 Following further analysis and discussion with key users, the ABS determined the potential for distortion from multiple counting of changes in transaction prices was low. An advantage of the gross industry approach is improved coverage of transactions primary to the targeted industry of the economy.
Weights and pricing
2.31 While there is a conceptual difference between the gross and net industry approaches, the net measures are an analytical construct from gross measures allowing the possibility for the ABS to develop indexes on both bases.
2.32 The I-O tables, used in the weights that underlie the PPIs, may be produced under either a gross or a net approach. It is possible to develop sufficiently detailed price specifications that would enable respondents to provide data to support both gross and net industry indexes.
ITPI and SOP
2.33 The gross/net industry distinction is not applicable for the ITPIs due to the price measurement occurring for the EPI when the goods leave Australia and when goods land in Australia for IPI.
2.34 The Stage of Production (SOP) framework is constructed on a gross basis to capture a whole of economy perspective. Developed as an analytical tool to support the study of inflation, the products represented by the SOP indexes are presented by industry and by stage of production. In order to avoid multiple counting of transactions, the three stages, final, intermediate and preliminary are not aggregated. The organising structure of the PPIs, including the SOP framework is discussed in Chapter 4.
PURPOSE AND CONCEPTUAL APPROACH
2.35 To support ANA and BOP compilation, a coherent measurement basis for the deflation of total gross output as measured in the Australian System of National Accounts (ASNA) is required. As the concepts underlying the PPI must relate to those underlying the ASNA, the gross industry indexes are preferred.
2.36 PPIs provide inflation readings associated with gross output, and intermediate consumption (input) for the economy. Central banks and other macroeconomic policy decision makers use PPIs when evaluating inflationary pressure. The net industry approach, which removes instances of multiple counting of price movement impacts, for a given industry, is the most appropriate for the purpose of inflation monitoring.
2.37 The net industry approach is also preferred for the indexation of contracts, when monetary amounts are adjusted for changes in inflation. While the ABS neither endorses nor discourages such use, when considering using PPIs and ITPIs for contract indexation, users should take into consideration whether the indexes are compiled on a gross or net basis and whether this basis is appropriate for their requirements.
ABS POSITION
2.38 The ABS is of the view that the principal purpose of the PPIs and ITPIs is to support the compilation of the ANA and BOP. PPIs should therefore be constructed on the gross industry approach, the most coherent basis with the ASNA. The secondary purpose, to support short term inflation monitoring is provided by indexes constructed on an alternative basis, such as the SOP indexes.
2.39 If the SOP indexes were found to be not fit for purpose, and a cost benefit analysis suggested there was a case for net industry indexes, one outcome may be to provide outputs on both conceptual approaches. The ABS notes that while there is a conceptual difference between the gross and net industry approaches, the net industry measures are an analytical construct from the gross industry measures. Both can be derived from a common dataset.
USER COMMENTS
2.40 Users are invited to comment on:
- Whether the principal purpose of the PPIs and ITPIs is for the provision of price indexes for ANA and BOP compilation and therefore that the gross industry approach is the most appropriate; and
- The usefulness and demand for additional PPIs on the alternative, net industry basis.
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