Which producer prices lead consumer prices?

This study investigates the dynamics of producer price inflation, and its role in predicting future consumer prices. Despite recognized stylized facts, recent empirical assessments of producer price inflation, a valid proxy for supply chain volatility, yield conflicting conclusions regarding the presence of pass-through. To address this gap, we use monthly data from January, 2002 through December, 2021, and employ a heterogeneous agent vector autoregressive model to disaggregate the producer price index into its fifteen weighted commodity groups and quantify short-run pass-through, identify causal direction, construct impulse-response functions, and conduct forecast error variance decompositions. In contrast to conventional measures, many disaggregated producer price series exhibit significantly stronger magnitudes, and statistical significance in both impulse-response functions and pass-through coefficients. Notably, consumer price responses to disaggregated producer price shocks demonstrate heightened significance relative to the aggregate producer price series. More interestingly, unlike, the aggregate producer price series, we identify several weighted disaggregated series that unidirectionally influence or “cause” consumer price inflation providing valuable information for forecasters and policymakers. Finally, we ascertain that three specific disaggregated producer price indices alone account for approximately two-thirds of the variation in consumer price inflation forecasts. These findings underscore the importance of disaggregation in macroeconomic reduced-form modeling, and the potential for aggregation bias in highly aggregated series to mute key variation in underling disaggregated components.