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

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  • Shang-Jin Wei
  • Yinxi Xie

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.

Suggested Citation

  • Shang-Jin Wei & Yinxi Xie, 2018. "The Wedge of the Century: Understanding a Divergence between CPI and PPI Inflation Measures," NBER Working Papers 24319, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:24319
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    Cited by:

    1. Wei, Shang-Jin & Xie, Yinxi, 2020. "Monetary policy in an era of global supply chains," Journal of International Economics, Elsevier, vol. 124(C).

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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • F1 - International Economics - - Trade

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