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6427.0.55.004 - Information Paper: Outcome of the Review of the Producer and International Trade Price Indexes, 2012  
Latest ISSUE Released at 11:30 AM (CANBERRA TIME) 06/03/2012  First Issue
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CHAPTER 3: THE FUTURE SUITE OF PRODUCER AND INTERNATIONAL TRADE PRICE INDEXES
Introduction
User Views
Evaluation
Outcome

INTRODUCTION

3.1 Following extensive consultation, the Australian Bureau of Statistics (ABS) has determined that the principal purpose of the PPIs and ITPIs is to measure inflation by industry to support the compilation of the National Accounts and Balance of Payments. This requires that their compilation be on a basis coherent with the 2008 System of National Accounts (2008 SNA), and Balance of Payments and International Investment Position Manual, Sixth Edition (BPM6) statistical framework and on a gross industry basis, and is consistent with supporting other purposes of the PPIs and ITPIs.

3.2 In light of this decision, this chapter outlines an evaluation of whether the current suite of indexes supports the principal purpose, and whether improvements may increase their usefulness for the compilation of the National Accounts and Balance of Payments.

3.3 Additionally, this chapter assesses current and alternative indexes for the support of inflation monitoring.


USER VIEWS

3.4 User comments focused on the options provided in the Information Paper: Review of the Producer and International Trade Price Indexes, 2011 (cat. no. 6427.0.55.003) regarding the presentation of the PPIs and ITPIs.

3.5 Users noted that the ability to monitor inflation was a requirement of the suite of PPIs.

3.6 Additionally, users noted that the ability to gauge demand side inflation was a requirement, and that these needs were met by National Accounts domestic final demand (DFD) implicit price deflators (IPDs) and chain price indexes.
EVALUATION


CURRENT INDEX ALIGNMENT WITH THE PRINCIPAL PURPOSE

3.7 The current suite of PPIs is based on the 2008 System of National Accounts (2008 SNA) Input–Output (I–O) framework.

3.8 The 2008 SNA I–O framework is part of the National Accounts, complementing the quarterly and annual series of national income, expenditure and product aggregates. The tables within the I–O framework (I–O tables) provide detailed information about the supply and use of products in the Australian economy and about the structure of and inter–relationships between Australian industries. The detailed information in the tables is used to derive the weights for the PPIs and provides the full extent of the PPI and ITPI scope and coverage.

3.9 As discussed in Chapter 2, the National Accounts and Balance of Payments use the PPI and ITPIs price series at a disaggregated (detailed) level for the calculation of chain volume measures.

3.10 For the compilation of the PPIs and ITPIs these detailed series are aggregated into a suite of indexes. The current suite of PPIs and ITPIs are:
  • Manufacturing industries producer price indexes;
  • Construction industries producer price indexes;
  • Copper materials price index;
  • Mining industries producer price indexes;
  • Services industries producer price indexes;
  • Stage of Production Indexes (SOP) producer price indexes; and
  • International Trade Price Indexes (ITPIs).

3.11 Appendix 2: Price indexes and the 2008 System of National Accounts, further explains the relationship between the PPIs and ITPIs an the I–O framework. The relationship is illustrated by diagrams which overlay the 2008 SNA I–O framework with the available ABS price indexes.

3.12 The ITPIs are important complements of domestic PPIs. Imports and exports are included within the 2008 SNA I–O framework as primary inputs and final demand respectively. However unlike the PPIs which are weighted according to the I–O tables, the price indexes for ITPIs are weighted using International Merchandise Trade data. The ITPIs are compiled on this basis to provide a set of internationally comparable statistics.
MOVING THE INDEXES FROM A PRODUCT BASIS TO AN INDUSTRY BASIS

3.13 The ABS investigated whether changes could be made to the suite of PPIs (excluding SOP and ITPIs) to improve their usefulness for the compilation of the National Accounts and Balance of Payments.

3.14 As discussed in Appendix 2, an I–O table has products in its rows, and has industries and final demand in its columns.

3.15 The current basis of the PPI input indexes, when aggregated, relates to selected products used by an industry for the production of their output. The input index basis therefore, relates to the selected products of the column of an I–O table (at purchasers' prices). An example of a current ABS input index is the Materials Used in Manufacturing Industries (MUMI), shown in the solid shading in Diagram 3.1 below.

DIAGRAM 3.1 – CURRENT AND FUTURE MANUFACTURING INPUT INDEXES,
INPUT–OUTPUT FRAMEWORK AT PURCHASERS' PRICES
Diagram: Diagram 3.1 – shows the current and future manufacturing input indexes based on the input–output framework at purchasers' prices


3.16 The current basis of the PPI output indexes, when aggregated, includes produced products primary to the industry that are sold or transferred within or outside that industry (for further processing, consumption, used as capital equipment, or exported). The current output index basis therefore relates to the rows of an I–O table (at basic prices). An example of a current ABS output index is the Articles Produced by the Manufacturing Industries (APMI) shown in the solid shading in Diagram 3.2 below.

DIAGRAM 3.2 – CURRENT AND FUTURE MANUFACTURING OUTPUT INDEXES,
INPUT–OUTPUT FRAMEWORK AT BASIC PRICES
Diagram: Diagram 3.2 – shows the current and future manufacturing output indexes, based on the input–output framework at basic prices


3.17 Diagrams 1 and 2 in Appendix 2 highlight that the current PPIs cover very little of the economy with input indexes and roughly half of the economy with output indexes. Diagrams 3 and 4 illustrate the index scope required of the PPIs to fully service quarterly and annual National Accounts and Balance of Payments compilation needs.

3.18 PPIs are presented by industry in ABS publications. This implies an I–O framework column approach has been taken, but as discussed above, the output indexes, which are the majority of the available indexes, have an I–O framework row approach. While the ABS goes to some effort to accurately describe the PPI basis, a simpler, more intuitive presentation was considered.

3.19 To provide a more useful view of the economy, the ABS input and output PPIs, when aggregated, should represent the industry dimension of the I–O framework, that is, the columns should form the basis of the indexes (see Diagrams 3.1 and 3.2 above for examples for the Manufacturing industry).

3.20 This representation will include all products (not only primary products) used or produced by an industry and be inclusive of non–market products.

3.21 Changing the basis of the indexes will not improve the usefulness of the PPIs for the compilation of the annual National Accounts. This is because the annual National Accounts use PPI information at a disaggregated level, and therefore aggregated indexes, in whichever presentation, are not required for their compilation.

3.22 However, changing the basis of the indexes will provide some improvement to the usefulness of the PPIs for the compilation of the quarterly National Accounts. This is because the quarterly National Accounts use PPI information a more aggregated level than the annual National Accounts.

3.23 Additionally, the National Accounts produce macroeconomic statistics on an industry basis. To improve coherence between the PPIs and the National Accounts, the PPIs should be aggregated on a consistent basis.

3.24 By changing the basis of the output indexes, the interpretability of the indexes will be improved, as an industry basis will simplify the meaning of the indexes for external users, (i.e. indexes will represent the inputs or outputs of a given industry) and provide coherence with National Accounts estimates. Diagrams 3 and 4 in Appendix 2, illustrate aggregate indexes, such as intermediate inputs and total supply, which would be available if the I–O framework was completely populated by PPIs.

3.25 As discussed above, the current output PPIs represent market prices of products primary to an industry. Therefore all other products produced by that industry are excluded as are non–market prices (for example, the price of general government services such as national defence, the value of owner occupied dwellings and other non–market activities where prices are not economically significant).

3.26 If the basis of the PPIs is to capture price movement for all products represented in the I–O framework, then non–market activity should be captured. Where the non–market activity closely resembles a market activity (e.g. education), the market price index may serve as a proxy for a non–market price movement. However, some non–market activity where market equivalents are unavailable (e.g. national defence) is valued at production cost, and there is no basis for constructing an explicit price index. The ABS will investigate how to reflect non–market products (as represented in the National Accounts) within the PPI release. The inclusion of indexes those reflecting non–market prices is dependent on the development of a new Prices system, which is expected in mid 2014.

3.27 Over time, establishment production levels shift in response to economic conditions. Some products and industries become more important while others become less important. Therefore the rationale for the re-weighting of indexes is to ensure the most representative statistics possible. The PPIs were last re-weighted for the September quarter 2009 (based on the 2001–02 I–O tables). The Review of the PPIs and ITPIs presents an opportunity to re–weight the individual PPIs indexes based on the latest available I–O tables (i.e. in respect of 2007–08). The timing and methodology for future re–weighting of the PPIs is discussed in Chapter 5: Other issues.

Findings

3.28 The ABS can improve the coherence of the PPIs with the National Accounts by presenting the indexes on an industry basis, and updating the weights.


INDEXES FOR THE SUPPORT OF INFLATION MONITORING

Introduction

3.29 The National Accounts and Balance of Payments require disaggregated and aggregated price indexes for their compilation. Others users make use of aggregated and disaggregated indexes for inflation monitoring. Users noted that the ability to monitor inflation was a requirement of the suite of PPIs.

3.30 During the process of reviewing the current indexes, the ABS established a principal purpose but noted there were other purposes for the PPIs. As discussed in Chapter 2, indexes designed to support the National Accounts and Balance of Payments represent all transactions occurring in the economy. As products flow through different production processes within an industry, price movements will be counted multiple times. They are therefore useful individual indexes but are not principally designed as economy-wide summary measures for inflation monitoring.

3.31 To meet users' needs, the review evaluated alternative presentations of the I–O framework which could provide such economy–wide summary measures of price change which are specifically designed for inflation monitoring.
Stage of Production Indexes

3.32 The SOP indexes are the current economy-wide compilation for all existing PPIs and ITPIs, which provide information for inflation monitoring. The output index basis of the SOP indexes conforms to the I–O framework. Therefore, there is no need to modify the current scope of the SOP indexes. The concepts underpinning the SOP index presentation are explained in detail in Information Paper: Producer and International Trade Price Indexes, Concepts, Sources and Methods (cat. no. 6429.0).

3.33 The name SOP refers to the stages of production before a product is deemed final and is then either consumed, used as capital or exported. In the case of the SOP indexes, the last three stages of production are represented where products may be assigned to any, or all three stages. The stages are:
  • Stage 3 (Final)
  • Stage 2 (Intermediate)
  • Stage 1 (Preliminary)

3.34 Imports into the production process are included within the indexes as they represent a source of inflationary pressure. While the main emphasis of the SOP presentation is the analysis of price change in the domestic economy, the current SOP indexes provide both “with exports” and “without export” views of producer price changes.

3.35 Additionally, the SOP indexes are constructed on a gross industry basis (gross industry indexes are discussed in Chapter 2), matching the concept supported by the principal purpose of the PPIs. SOP indexes minimise the multiple counting issue by segmenting the economy into stages, and measuring the price change of the transactions with the next stage. The stages cannot be aggregated, however a summary headline statistic of a general measure of inflation is provided for each stage.


Use of the SOP indexes

3.36 Internally, the SOP indexes allow for an effective data confrontation with the individual PPI time series. This provides one avenue for maintaining the quality control for the underlying PPI time series.

3.37 Externally, the SOP indexes provide analysts with economy-wide, disaggregated and aggregated price information by stage of production. Users support the continuation of the SOP indexes.

3.38 The disaggregated industry information provides the concurrent (i.e. for the same time period) contribution of a product's price change to each stage headline. For example Stage 2 will reflect the same price change in aluminium ingots which are used in the earlier Stage 1 for the same reference period. The headline aggregates for each SOP index therefore provide a concurrent comparison of the total effect of product price change for each stage. The stage headlines differ due to the probability of there being different products with different contributions (weights) in each stage.

3.39 The SOP indexes are further disaggregated to allow comparison of final consumer domestic and final consumer import price inflation contributions, and comparison of final capital domestic and final capital import price inflation contributions. SOP Final Demand also allows a breakup of price changes between consumer goods (household and government) and capital goods. SOP consumer and capital import price data facilitate comparisons of price changes with respect to exchange rate variations. This provides some indication of the influence of exchange rates on domestic producer inflation.

3.40 From their inception, however, there was an expectation that the SOP indexes would provide a leading relationship to the Consumer Price Index (CPI). ABS research has shown this relationship not to be clearly apparent to date, instead a contemporaneous relationship exists for all three SOP stages and the CPI. This signals that price propagation may be far more rapid than can be measured by a quarterly index, or businesses operate in a more fluid way, expanding and contracting margins to compensate for business cycle influences. For further information on the use of the SOP indexes, see Appendix 3: Interpretation of the Stage of Production indexes.
Improved quality of the SOP indexes

3.41 The SOP indexes are currently classified according to the Australian and New Zealand Standard Industrial Classification (ANZSIC) 1993. However, this classification has been superseded by the ANZSIC 2006 edition (ANZSIC 2006). The SOP indexes will be updated to ANZSIC 2006 to maintain their relevance to the contemporary economic climate and consistency with the other ABS data. Further information on the conversion of the SOP indexes to ANZSIC 2006 is provided in Appendix 4: Stage of Production and implementation of ANZSIC 2006, as is an indicative presentation of the SOP indexes structured on an ANZSIC 2006 basis.

3.42 The SOP indexes are currently weighted according to the 1996–97 I–O tables. At the same time as implementing ANZSIC 2006, the SOP indexes will be updated to use weights from 2007–08 tables. This will maintain their relevance. The timing and methodology for future re–weighting of the SOP indexes is discussed in Chapter 5.

3.43 Implementation of ANZSIC 2006 for the SOP indexes will include:
  • some restructuring and/or renaming of previous ANZSIC 1993 PPI series;
  • discontinuation of series; and
  • introduction of some new series.

3.44 In concept, the SOP indexes incorporate all flows of goods and services within the economy. However, while goods are reasonably well represented in the SOP indexes, there is a lack of broad coverage of services, including the major margin service areas of retail margins and wholesale margins. The current SOP indexes cover approximately half of total expenditure based on 2006–07 I–O tables. This coverage shortfall is a direct follow on from the limited coverage of service industries and the construction industry in the current ABS suite of PPIs. The coverage expansion strategy for services prices in the PPIs is discussed in the chapter: Quality improvement and coherence of the Producer and International Trade Price Indexes.

3.45 As coverage of the PPIs expands, the SOP indexes analytical power and representativeness of the economy will improve. Any expansion to the SOP indexes will be communicated ahead of time in the publication Producer Price Indexes, Australia (cat. no. 6427.0).


Improved terminology for the SOP indexes

3.46 The current naming of the three SOP stages as Preliminary (Stage 1) Commodities, Intermediate (Stage 2) Commodities and Final (Stage 3) Commodities has caused some confusion with interpretation. The inference that there are only three stages of production culminating in the Final (Stage 3) Commodities, is incorrect.

3.47 The ABS has chosen three stages to represent the Australian economy, but there can be many stages. However, beyond three stages, only a marginal informational increase to economic analysis may be realised.

3.48 In an effort to clarify and confusion, the stages will to be renamed to reflect the relationship of the stages of production to final demand. Accordingly, the ABS will use the following terminology:
  • Stage 3 (Final) will become Final Demand – Products consumed as Final Demand;
  • Stage 2 (Intermediate) will become Intermediate Demand – Products consumed as inputs into the production of Final Demand; and
  • Stage 1 (Preliminary) will become Preliminary Demand – Products consumed as inputs into the production of Intermediate Demand.

Domestic Final Purchases indexes

3.49 The Domestic Final Purchases (DFP) indexes were reviewed for inclusion within the suite of PPIs after user consultation found a requirement to gauge economy–wide demand side inflation.

3.50 DFP indexes are complementary to the SOP indexes. Unlike the SOP indexes, DFP indexes gauge demand side inflation in a similar way to the National Accounts Domestic Final Demand (DFD) indexes. DFP indexes take a consumer’s view of price change with prices measured at purchasers’ prices. The DFP indexes were examined in the Information Paper: Price Index of Domestic Final Purchases, Australia (cat. no. 6428.0).

3.51 Conceptually, the DFP indexes are economy–wide and their scope relates to final purchases of goods and services by Australian residents in the Australian economy, whether produced domestically or imported. The DFP indexes adopt a market transactions approach and exclude non–market goods and services.

3.52 The DFP indexes do not currently exist and their production would incorporate: Consumer Price Index (CPI) plus adjustments to reflect Household Final Consumption Expenditure (HFCE) weighting; input prices for government (with underlying prices from PPI and CPI collections adjusted to reflect purchasers’ prices) and investment (fixed asset construction), for which prices are not currently collected for the entire industry. Significant data gaps (primarily relating to services and outputs from the construction industry) exist for the data required to compile the DFP index.

3.53 There is neither currently internal nor external demand for DFP indexes. Users seeking a DFP type measure currently use the DFD implicit price deflators, understanding that they are not pure price indexes.


Bureau of Labor Statistics PPI experimental aggregation system

3.54 An alternative inflation monitoring concept has been developed by the United States (US) Bureau of Labor Statistics (BLS). BLS PPI program's experimental aggregation system (EAS), like the SOP indexes, is based on an economic categorisation of transactions according to production chain sequencing.

3.55 The BLS designed the EAS as an input index based on an I–O framework, although it is constructed from producers’ output prices which are used as a proxy for actual prices paid by the buyer (purchasers’ prices).

3.56 The EAS is an extension of the existing US Stage of Processing system currently published by the BLS, expanding the existing two stages of intermediate processing plus final demand, to four stages of intermediate processing plus final demand. In addition, the EAS expands the products covered from the existing unprocessed goods and processed goods, to include services and construction. It is a domestic inputs based framework where imports are out of scope for the stage of processing aggregations.

3.57 The EAS is designed to track prices of inputs consumed by industries classified in each of the four stages of processing, allocating a product to final demand and to one, and only one, intermediate stage of processing.


Findings

3.58 In addition to indexes compiled to serve the principal purpose, the need to serve the secondary purposes of inflation monitoring will be achieved by continuing to compile the current SOP indexes.

3.58 Despite some shortcomings, the SOP indexes provide meaningful aggregated and disaggregated price change measures and are the only viable economy-wide presentation available in the short term. Users support the continuation of the indexes, although the SOP concepts should be better articulated to users. The implementation of DFP indexes will no longer be pursued.

3.59 The ABS prefers to adopt an inflation monitoring approach which allows products to be classified to multiple stages.
OUTCOME

3.60 The ABS will continue to publish input and output indexes, as this supports the compilation of macroeconomic statistics such as the National Accounts. From the September quarter 2012, the indexes will represent an industry, rather than a product (primary to an industry) view.

3.61 The current SOP index compilation will be retained for the PPIs and ITPIs, providing a transactional flow basis for inflation monitoring. The underlying concepts of the SOP indexes remain unchanged.

3.62 From the September quarter 2012, the ABS will re–weight the individual PPIs and SOP indexes based on the latest available I–O tables (i.e. in respect of 2007–08). The SOP indexes will be reclassified according to the ANZSIC 2006.

3.63 From the September quarter 2012, the ABS will provide further clarification on the concept of SOP indexes in the Explanatory Notes of the publication Producer Price Indexes, Australia (cat. no. 6427.0) and within an updated Producer and International Trade Price Indexes: Concepts, Sources and Methods publication, which will be released in early 2013. To aid in this clarification, the SOP indexes will be renamed as follows:
  • Stage 3 (Final) will become Final Demand – Products consumed as Final Demand;
  • Stage 2 (Intermediate) will become Intermediate Demand – Products consumed as inputs into the production of Final Demand; and
  • Stage 1 (Preliminary) will become Preliminary Demand – Products consumed as inputs into the production of Intermediate Demand.

3.64 From the September quarter 2014, the introduction of a new computer system will allow the coverage of the PPIs to include non–market price indexes.

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