The Wedge of the Century: Understanding a Divergence between CPI and PPI Inflation Measures

Shang-Jin Wei and Yinxi Xie ()

No 24319, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Two strands of the literature suggest that PPI inflation, rather than CPI inflation, should be the targeting variable in a monetary policy rule. The distinction between these two rules would only be important if the two inflation indices do not co-move strongly. The first contribution of this paper is to document that the two inflation gauges did co-move strongly in the last century but the correlation has fallen substantially since the start of this century. The second contribution is to propose a structural explanation for this divergence based on a lengthening of world production chains since 2000. This theory implies that the decline in the correlation is likely to be permanent and a rethinking of the monetary policy rules has become more important. Our multi-stage multi-country production model has additional predictions on the behavior of CPI and PPI inflation beyond a fallen correlation, and these predictions are also confirmed in the data.

JEL-codes: E5 F1 (search for similar items in EconPapers)
Date: 2018-02
New Economics Papers: this item is included in nep-mac
Note: ITI ME
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Citations: View citations in EconPapers (2)

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