The PPI says: Service Sector Deflation is Almost Here

Posted by: Michael Mandel on February 19

When the producer price numbers were released this morning, everyone fixated, as usual, on the Producer Price Index for Finished Goods. So you can find plenty of sites on the web which will tell you that the PPI for Finished Goods rose by 0.8 percent in January, and by 0.4 percent after taking out food and energy. And most news reports will focus on higher inflation. CNNMoney, for example, has a headline which says “Wholesale prices higher than expected.”

But these types of headlines are deceptive. First of all, it’s better to measure inflation over the past year. By that measure, finished goods prices are down by 1%.

More importantly, finished goods inflation—which is found on the first page of the release—is not the critical piece of data in today’s report. Buried in the back, on pages 21 and 22, the Bureau of Labor Statistics also tracks the prices paid for services—not just the services consumers purchase, but the services that businesses buy as well.

And what these numbers show is that the service sector inflation disappeared in January. That is, producer prices for “traditional service industries” were no higher in January than a year early. They did not rise at all. Nothing. Zero. Service sector deflation, here we come.

serviceppi_23920_image001.gif


This index—which has only been around for a couple of years—strikes me as being a better indicator of the true state of inflation in the U.S. than the finished goods index, or any index connected with manufacturing. Goods inflation is influenced by temporary swings in commodity prices, and by fluctuations in exchange rates. What’s more, the focus on ‘finished goods’ and ‘manufacturing’ may have been appropriate in a manufacturing-based economy of 20 years ago, but it makes no sense in today’s world, where manufacturing is a smaller and smaller share of output and employment.

By contrast, the category of “traditional service industries” includes a very wide range of industries, from health care to telecommunications to web search portals (like Google) to banking to real estate agencies to management consulting to waste collection, amusement parks, and hotels. It is a much better, broader reading of the economy.

The chart above shows the year-over-year change in prices for the traditional service industries, versus the price changes for manufacturing. Manufacturing prices have gone through gyrations with the price of oil and food. But service sector inflation has shown a steady downward trend, hitting an astonishing 0% in January.

There’s no way to know if this is unprecedented, because this data series is relatively new. But let’s just say that service sector deflation—or even flat prices—is highly highly unusual.

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Reader Comments

Gregory Ward

February 19, 2009 02:13 PM

Good point, thanks for digging this information out of the data.

GregW

Hugo van Randwyck

February 19, 2009 02:23 PM

Thank you for this article Michael. Interesting. It seems finally service inflation is coming down. Maybe like house prices, that have been inflated, service prices will become more realistic. Nice graph. Good to see BW doing graphs online in articles.

Viking

February 19, 2009 03:07 PM

To me this speaks to the fact that you have essential vs. non-essential consumption of services,as you have in the manufacturing sector and during hard economic times people cut back in both areas,necessitating cost reductions and productivity improvements.As an example,if the government is successful in computerizing all medical records,as proposed,it will require fewer people in health care,driving down costs,as we have seen in the travel industry among others.Having worked for a public agency for many years I know for a fact that even modest and easily attainable productivity inprovements,would mean that all government agencies could operate efficiently with far fewer workers.I am not convinced that we can invent our way to full employment,as many of the new inventions will provide further productivity enhancements,thus requiring fewer workers.

Mark

February 19, 2009 04:12 PM

While I agree with the argument that the service sector numbers may be more indicative of the actual US ecomomy than the manufacturing numbers, you completely lost in the last paragraph.

How can you say, on the one hand, that there is no way to know if flat prices is unprecedented and then turn around and say it is highly highly unusual. The fact is the data has not been collected for long enough to draw any conclusions about it one way or another.

Rob

February 19, 2009 04:25 PM

Not such a simple problem inflation. Service Sector inflation is down, is that because so many people are out of work wages have dropped? Is that a good thing? For most mortal humans (not the "elite" business clique who can make million$ destroying companies and economies), food, housing and energy are the most significant components of their personal P&L. Why is this so difficult to understand (or are we trying to look the other way...)

Rob

February 19, 2009 04:29 PM

The other scary thing about inflation is that-while there is deflation in certain "bubble" sectors like housing, I'm not sure that's going to be the general rule. Companies that produce REAL products (like food, housing and energy) have FIXED costs. As the economy sours and production drops, these costs tend to stay FIXED. And you have to make up for them if you want to stay in business. Once you've cut to the bone there's only two things left to do. Raise prices or shut down.

Bill Gates

February 19, 2009 04:31 PM

Nothing new to anyone in the IT services sector. Been happening for 9 years.

Joe Cushing

February 19, 2009 05:04 PM

Interesting post. I'm learning over here. It looks like people are just stuck in the old way. Maybe with people like you educating us, people will come around.

Kartik

February 19, 2009 06:01 PM

Why is this a surprise when services can be exported to lower cost countries to easily?

Also, does this include healthcare and college tuition? If it does, it shows that non-healthcare and non-college forms of services are deflating very rapidly, as healthcare and college tuition are still rising rapidly in price.

Ann

February 19, 2009 07:12 PM

Not a profound comment. Testing to see if my response goes through. Off the top of my head, there are many services people have used that they could do themselves if they had more time than money. For instance, even with time constrictions and sufficient income, I cut my husband's hair and he changes our cars' oil. We live in a rural area, and some services are a hassle or not available. With increasing unemployment, I'm guessing some services in some locations are dropping prices in a desperate effort to stay in business.

KK

February 19, 2009 09:50 PM

AT&T, Dish Network, my stock charts service, my homeowners' association and even my regular barber have all raised their prices anywhere from 5% to 25%, just in this last two months.

Is the author of this article talking about some country other than USA?

KK

February 19, 2009 09:56 PM

What we actually see is that wages have been going down but the prices of services have been going up.

PPI is not in line with the actual experience of consumers.

stevemcgee99

February 19, 2009 10:11 PM

First of all, inflation means increase in the money supply.

This is important to note, because inflation will cause increase in prices in general (more supply decreases exchange value).

What it does not mean - and this is also important - is an immediate increase in all prices. That 'monetarist' assumption is probably why most people call 'increase in price' inflation and 'decrease in price' deflation.

So, why would service sector prices decrease? Because the businesses are experiencing decreased sales (less demand), and so are lowering the prices to increase sales/revenue.

You see, inflation DOES NOT cause immediate increase in prices all around. Where the first price increase is found is where the newly created money goes first - defense, government contracting, housing, bank salaries. A likely second market for new money to go is luxury items, vacations, etc.

What is new money? It's funds created by the Federal Reserve Bank, plus all the multiplied money loaned by each bank - up to 100 times their total deposits.

So, most people's salaries don't increase immediately when there is inflation - that's a well-understood problem. That means, out of the total available spending money for a person, an increase in prices one place will mean decrease spending somewhere else.

In the same way, company budgets don't increase immediately when there is inflation. So, increase in prices in one area means less spending somewhere else - in this case it's services. Companies are firing redundant/unproductive staff, and also focusing their staff's efforts more closely on profitable activity. This will also lead to less demand in service. *When you have no budget, you have to do it yourself!

One last 'political' comment - the insidious thing about inflation, an increase in the money supply, is that it is unilaterally started by the Federal Reserve. Like stock splits, it decreases the value of all dollars in the market. Unlike stock splits, all holders of dollars don't realize an increase in volume - in effect inflation is like a stock split only for preferred shareholders or other insiders, who gain on the dilution of stock value while those who don't get any of the additional stocks lose.

That's a very specific, moral reason to end the fiat currency dollar and to return to a commodity/gold standard.

eBookCovers

February 19, 2009 10:21 PM

Thanks for digging up this info Michael, it has been eye-opening. Also a thought provoking graph that you've included..
-The ebook covers guy.

Strategery

February 19, 2009 11:42 PM

I would welcome some deflation in the services industries. Tuition at a university in my area went up 103% in 9 years, and they are asking for another 8%!

Tom Krebsbach

February 20, 2009 12:01 AM

This is a fascinating chart. It would be interesting to see what it looks like a couple years further back.

I am wondering what the correlation is between the two different sectors: goods and services. Assuming there is a maximum amount of production that can take place at any one time, a great increase in prices in one sector would necessarily cause a limited increase in prices in the other sector. This appears to be the case where the price of goods (fuel, food, other consumer goods) went way up in price, while the increase in service prices was held down. Now that the cost of goods is deflating, we might expect to see a rise in inflation of services in the near future. Of course this will be tempered by the overall deflationary mood of the economy.

KK

February 20, 2009 11:38 AM


What a delusion!!

Charts and economics are meaningless if they do not reflect the reality!

The reality is that we are experiencing increase in prices that the consumers have to pay for services. The prices of all essential services are going up, not down!! Is n't that what we would expect with increased money supply from the government's printing presses? Moreover, as business volume decreases, the only way businesses can survive is by charging more from the remaining customers. They can no longer increase the customer base by lowering their prices because of high unemployment.

lightly

February 20, 2009 03:08 PM

I wonder how that chart would look without adding healthcare to the services?

Ludwik Kowalski

February 20, 2009 03:53 PM

Dear reader,

1) Please reply, or forward this to a teacher of elementary economics.

2) I have asked a trivial question about prices at:

http://www.opednews.com/articles/Supply-and-demand-by-Ludwik-Kowalski-090216-588.html

3) Please help me to identify a mistake in my reasoning, either at the above website or via email:

kowalskiL@mail.montclair.edu

Thanks in advance,
Ludwik Kowalski

taxpayer

February 20, 2009 09:29 PM

Look at the cost increases of:
1.government-city,county,state,federal

2. health care

3. education -pre school through college
these are the real inflators that cause deflation in other areas.

stevemcgee99

February 21, 2009 01:27 AM

Inflation = Increase in money supply

Deflation = Decrease in money supply

Don't confuse changes in prices with changes in money supply. It will help everyone understand what is happening better.

Inflation will result in increases in prices - eventually. But the effects of adding dollars to the economy is not simultaneous nor synchronized across products and services (the reason for this is not everyone gets the increased dollars at first, only some have access to them).

Because most people's earnings are not affected by the increase in dollars as quickly as the prices of goods, most people will have less to spend after the Fed increases the money supply.

Demand for services has decreased because of layoffs, decreased sales, etc., so to attempt to increase service sales, companies are discounting. That is not "deflation", it is a decrease in prices *in that sector*. But, as many have mentioned, not ALL services prices have decreased...

yamada

February 21, 2009 09:24 AM

Yes...good point.
US is heading for deflationary spiral.
By lack of aggregate demand and by adjustment of balance sheet of entities.
But by make using of this deflation, there is a way for breakthrough, by Yamada Model as below:

To reform the balance sheet of entities, it’s best to take the following measure.

Bubble is caused by peoples’ expectation that the price of certain asset(real estate) will rise in future, with bank's pouring high-powered money to the asset side of economic entities’ balance-sheet. And one day it busted. So, to solve this problem, such asset bubble on economic entities’ balance-sheet must be gotten rid of, by the new system as below.

1. Every economic entities’(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe on calculated basis by law firm, on assuming the bankruptcy filed), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic entities..
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next legally enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, in proportion to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all and absorbed by tax authority.
4. Other economic entity that gets profit from the written off by the bank should next legally enforced to, by using the profit from the written off as original fund, write off its loan(or trade claim) to its each debtor, in proportion to the amount of insolvency of each debtor. If the economic entity is unable to use all profit it earned, the remainder is taxed all and absorbed by tax authority. These processes are to be repeated operationally(multiplier effect).
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. The tax claims is finally assigned to FRB(or a public institution established). It’s up to FRB how they dispose of their above claims, considering the situation of economy, of each bank and of each economic entity. As a option FRB should examine the possibility of the bank’s and the economic entity’s turnaround, together with the other creditors, remaining desirable debt to the bank and the economic entity(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA), and writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and traceable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic entity, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic entity that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic entities, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. FRB should carefully watch the rate of the number of insolvent economic entities to the number of all economic entities in the US, when deciding the amount of the loans(trade claim) written off on 2.
10. To keep FRB’s balance sheet sound, it must be permitted for FRB to generate profit by printing dollars in order to cover write-offs loss. These printed greenbacks is stored to the safe forever(I come to know the journalization if FRB’s profit is generated by their printing dollars is quite irregular). This may be extraordinary bookkeeping nowadays, but it should be permitted, under extraordinary situation.
11. In case price inflation expectation exists(not now), the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic entities.

For further details, please see the post on the blog as below:

The Post on December 16, 2007, August 14, 2007 on the blog
http://reversewealtheffect.blogspot.com/

RayG01

February 21, 2009 05:25 PM

Clarification for some:

Deflation favors those who save, and those who lend.

Inflation favors those who spend and borrow.

Seeing prices fall in a given industry such as IT is not a sign of deflation. The technology and the knowledge behind it became less scarce, and thus more affordable.

If that doesn't blow your hair back just right, think of how much the first CD players cost, as compared to now. Technology becomes more affordable over time.


And cost increases in health care or education are not signs of deflation either. If State University raises their tuition 10%, they could be doing that for a variety of reasons. In an economic downturn, many states are slashing funding for education - for example - and so schools will try to make that money up in other ways.

Instead of cutting funding to the Support Group for Minority Transgendered Students, they simply choose to keep funding things that have nothing to do with education, and raise the price of everything to pay for it.

Again, that has nothing to do with inflation or deflation.

Mr. Middle Class

February 22, 2009 11:15 AM

For those of use who have been around since before Eisenhower, all theoretical discussions become so much claptrap. There are years when you get screwed, and years when you think everything's Just Fine. For the young, (or at least those who weren't born into the lower money classes), this is the first time that their feeling of "entitlement" to all the really cool things China could make has begun to disappear. They feel insecure. Poor babies. Yes, you can get by on so little; most of the world does. Go to a third world country sometime. Deal with your psychological convulsions, and your besmeared self image. If you can, you'll survive. Otherwise... Theoretical discussions become so moot when you're worried about where the next meal will come from. Learn from it; get stronger from it. Deal with it.
Deflation is a wonderful thing for the strong and prepared; who the heck ever wanted to pay MORE for something? That the masters of the capitalist universe managed to convince the average Joe that was a good thing still amazes me. Basically, they got suckered. And now that realization is the one that really hurts them.

Thank you for your interest. This blog is no longer active.

 

About

Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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