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On the Divergence between CPI and PPI as Inflation Gauges: The Role of Supply Chains

Shang-Jin Wei and Yinxi Xie

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

Abstract: This paper starts by documenting a new fact that consumer price index (CPI) and producer price index (PPI) used to move in tandem within a given country around the world, but start to diverge after 2000. Understanding the source of divergence is important as it potentially affects optimal monetary policies. We propose an explanation via the lens of global value chains. With increased length of production chains, the baskets of CPI and PPI have become more different. We build a model with multi-stage production, and derive tractable analytical solutions to show this point. Moreover, in the model, as production becomes longer, both CPI and PPI become less responsive to a given shock to the first stage of production, and the reduction in responsiveness is greater for CPI. We show that the key predictions of the model are confirmed in the data. Furthermore, we compare model predictions at the country level using calibrations and empirical patterns, and find that the two line up well as well.

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