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THE RELATIONSHIP BETWEEN CONSUMER PRICE INDEX (CPI) AND PRODUCER PRICE INDEX (PPI) IN MALAYSIA Linda Then Wee Mei
Corporate Master in Business Administration
2011
Pusat Khidmat Maklumat Akademik
UNIVERSITI MAlAYSIA SARAWAK
P.KHIDMAT MAKLUMAT AKADEMIK
111111111 IIi'rni 111111111
1000246504
THE RELATIONSHIP BETWEEN CONSUMER PRICE INDEX (CPI) AND PRODUCER PRICE INDEX (PPI) IN MALAYSIA LINDA THEN WEE MEl
A dissertation submitted in partial fulfillment of the requirements
for the degree of Corporate Master in Business Administration
Faculty of Economics and Business UNIVERSITI MALAYSIA SARAW AK 2011
I
APPROVAL PAGE I certify that I have supervised and read this study and that in my opinion it confirm to
acceptable standards of scholarly presentation and is fully adequate, in scope and quality, as
a research paper for the degree of Corporate Master in Business and Administration.
Dr. Evan Lau Poh Hock
Supervisor
This research paper was submitted to the Faculty of Economics and Business, UNIMAS and
is accepted as partial fulfillment of the requirement for the degree of Corporate Master of
Economic and Business.
Prof. Dr. Shazali Abu Mansor
Dean, FEB
UNIMAS
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I
DECLARATION AND COPYRIGHT Name
: Linda Then Wee Mei
Metric number: 09031603
I hereby declare that this research is the result of my own investigation, except where
otherwise stated. Other sources are acknowledged by footnotes giving explicit reference and
a bibliography is appended.
Signature
Date
~(1~
.
:lit} 0&1)0/1
© Copyright by Linda Then Wee Mei and
UNIVERSITI MALAYSIA SARA WAK
HI
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WORDS OF ACKNOWLEDGEMENTS First of all, I would like to thank my supervisor, Dr. Evan Lau for him guidance
throughout the process of writing the research paper. He constantly motivates me to keep on
working on the research paper even though there are times at which I feeJ like giving up on
the research paper.
My word of gratitude also goes out to all my friends and course mates from UNIMAS
for their moral support and encouragement. Without them, this research would not be made
possible. At the same time, I would like to thank my wonderful parents who have always
motivated me to write this research paper until its very end.
On the whole, I would like to thank anyone and everyone (whom I cannot list out in
this acknowledge page) for their moral support and financial support.
Once again, thank you very much for all your helps. I appreciate it very much!
THANK YOU! IV
ABSTRACT (:he purpose of this research is to investigate that the relationship between producer price
index (PPI) and consumer price index (CP1) in Malaysia. In contrast with previous studies,
many information of the PPI to be useful forecasts improve to the CPI. The research use
monthly data of consumer price index (CPO and producer price index (PPI) from period
January 1986 to December 20 1~ The unit root test and Johansen co integration test is used
to investigate the transfer of change from consumer price index and producer price index, or
in other words to test the existence or not of a long-term relationship between the two
variables. Granger Causality test to find that there is uni-directional or bi-directional
causality between the PPI and CPI. The result shown that policy makers to rely more on the
link to between CPI and PPI and use changes in PPI to predict changes in CPI.
Keywords: Consumer price index; Producer price index; Unit root; Co-integration; Granger
causality
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TABLE OF CONTENT
NO.
ITEM
PAGE
Preliminary Pages
• Title Page
• Approval Page
• Declaration & Copyright
• Words of Acknowledgement
• Abstract
• Table of Content
• List of Table
• List of Figures
1. CHAPTER ONE
1.0 Introduction
1.1 The Trend of Consumer Price Index and Producer Price Index
1.2 Conceptual framework of CPI and PPI
1.3 Problem Statement
1.4 Objective of Research
1.5 Significant of Study
1.6 Scope of Study
1.7 Organization of Chapters
2
6
8
11 13 14 15 16 2. CHAPTER TWO
2.0
2.1
2.2
2.3
2.4
Introduction
Review of Consumer Price Index (CPI)
Review of Producer Price Index (PPI)
Review of Relationship between CPI and PPI
Summary
17 19 27 30 37 3. CHAPTER THREE
3.0
3.1
3.2
3.3
3.4
3.5
Introduction
Theoretical Framework
Research Design
Source Data
Methodology
Unit Root Test
3.5.1 Augmented Dickey-Fuller (ADF)
3.5.2 Philips-Perron(PP)
3.6 Cointegration
3.6. r The Johansen and Juse ius(l990)
3.7 Granger Causality
3.8 Summary
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43 43 44 45 45 45 46 47 48 50 51 52 TABLE OF CONTENT NO.
ITEM
4. CHAPTER FOUR
4.0 Introduction
4.1 Unit Root Test
4.1.1 Augmented Dickey-Fuller (ADF) and Philip-Perron (PP)
4.2 The Johansen Cointegration Test
4.3 Granger Causality Test
4.4 Summary
PAGE
54
54
54
56
58
61
5. CHAPTER FIVE
5.0 Introduction
5.1 Conclusion from the research
5.2 Policy Implementation
5.3 Limitation and recommendation for future study
5.4 Summary
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6. REFERENCES
70
vii
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62
65
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LIST OF TABLES TABLE
Table 1
Table 2
Table 3
Table 4
Table 5
Table 6
Table 7
PAGE DESCRIPTION
24 Review of Consumer Price Index (CPI)
29 Review of Producer Price Index (PPI)
38 Review of Consumer Price Index (CPI) and Producer Price Index (PPI)
55 Unit Root Test (Level)
55 Unit Root Test (First Difference Level)
57 Johansen and Juselius Cointegration Test Result
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Result of Granger Causality Test
LIST OF FIGURES
FIGURE
PAGE
Figure 1
Figure 2
Figure 3
Figure 4
DESCRIPTION
The Trend of Consumer Price Index in Malaysia, 1970-2010
The Trend of Producer Price Index in Malaysia, 1970-2010
Theoretical Framework - Relationship between CPI and PPJ
Summaries of Methodologies used to examine the Relationship CPJ and PPI
Vlll
6
7
43 53 CHAPTER ONE
INTRODUCTION
r.
1.0
lntroduction
In Malaysia, stock market barometers of the national economy, CPI and PPI as
the core indicators of economic performance, on the national economy and capital
markets have a profound impact. Thus, Consumer price and producer price focused on
have been primarily focused on trying to gauge the growth in the economy which is
designed primarily to gauge the level of price stability in the economy.
Consumer Price Index (CPI) is similarly to a cost of living (Triplett, 1999). CPI
is one of the most important economic indicators in any country. It is uses for
measurement of the rate of inflation, for indexation of public pension benefits and for
many policy purposes (Takanobu, 2000). The Consumer Price Index (CPI) provides
data on the month-over-month and year-over-year changes in the prices paid by urban
consumers for a representative basket of goods and services (Yusoff, 2000). It is the
main inflation report for the futures and financial markets. Unexpected rises in this
indicator usually lead to falling bond prices, rising interest rates, and increased market
volatility.
cpr
is a price index of measuring changes through time in the price level of
consumer goods and services purchased by household. (Boskin, Dulberger, Gordon,
Giliches & Jorgenson, 1998). Besides that, it calculates by national statistical agencies.
CPI is designed to provide broad measures of changes in retail price experienced by
Malaysian households as a group and should not be expected to exactly reflect the
2
experience of any individual household (Yusoff, 2000). Consumer prices are important
because consumer buying drives in the economy.
CPl also examines the weighted average of prices of a basket of consumer
goods and services, such as transportation, food and medical care. The CPl is
calculated by taking price changes for each item in the predetermined basket of goods
and averaging of the goods are weighted according to their importance. Changes in
CPI are used to assess price changes associated with the cost of living (Yusoff, 2000).
In the United States the major indexes of the seven points of goods, including are food,
wine and drinks house, Dress, Traffic, Medical health, Entertainment, Other goods and
services.
CPJ index is very important, but must be cautious with revelatory, because
released this index rose, the currency market, sometimes the opposite. Because the
consumer price index levels that consumer purchasing power, also reflects the
economic boom. When the country's consumer price index rising, shows that the
country's rising inflation, which is the buying power of a currency weakens, according
to the theory of purchasing-power parity, the country's currency should go weak. But
various countries to control inflation which inflation rising interest rates raise effect of
the opportunity and instead of the good. Conversely, when the country's consumer
price indexes show as inflation which is the buying power of a currency rises, the
country's currency should be stronger. When inflation under control and tends to
decline, interest rates will decline, instead of the light in this region.
Producer Price Index (PPl) was known as Wholesales Price Index (WPI) is
reported by many countries and is considered economic indicator. The PPJ index is a
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good predictor of future value of the CPI. In fact, a rise in the PPI index indicates that
retailers are buying goods and commodities at a higher price. This increases costs and
consequently will raise the price of the products see and this will be reflected in the
CPI Index (Hamid, Dhakar and Thirunnavukkarasu, 2006).
PPI is the indicator of inflation each month. It is published by the
u.s
Department of Labor in Bureau of Labor Statistics'. It measures the average change
over time in the selJing process received by domestic producers for their output. The
price included in the PPI is from the first commercial transaction for many production
and some services, those paid by importers for importing goods in Malaysia.
The PPI publication includes data on the month-over-month, quarter-over­
quarter. and year-over-year changes in PPI Data of PPI is included three categories of
production, which are finished good, intermediate goods and material. The
classification used for the in PPJ included Standard International Trade Classification 2
(S.I.T.C), National Account System
3 ,
and
International Standard Industrial
Classification4 (I.S .I.C)4.
Therefore, the producer price index is also leading inflation index, when the
production of raw materials and semi-finished goods prices, after several months, will
be reflected in prices of consumer goods and on the overall price level rise, cause
inflation (Hakkio, 2008). Conversely, when the index drops, production material price
in the production process will decline to effect overall price level fall down, abate
I Bureau of Labor Statistics is the principal fact-finding agency for the U.S government in broad field of
labor economics and statistic. 2 tandard International Trade Classification is a classification of goods used to classify the exports and imports of a country to enable comparing different countries and years maintained by United Nation. 3 National Account System is the internationally agreed standard set of recommendation to compile measures of economic activity. 4 International Standard Industrial Classitication is United Nations system for classifying economic data. 4
Pusat Khidmat Maklumat Akadcmik UNlVERSlTI MALAYSIA SARAWAK inflationary pressure. However, the data to include some commercial discount, unable
to fully reflect the real price rises will be exaggerated effect. In the foreign exchange
market, traders are concerned about the index. If the producer price index is expected
to higher inflation, the central bank may implement tighter monetary policy of the
currency, the favorable effect good. If the producer price index fell down, the opposite
effect.
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1.1
The Trend of Consumer Price Index and Producer Price Index
Figure 1: The Trend of Consumer Price Index in Malaysia, 1970-2010
I:~ex
I 120
.
100
80
60
-+-CPI
40 20 o
1970
_.-'' ---·~--·-·"----'i--·--···~--···--I-----r-----'---i
1975
1980
1985
1990
1995
2000
2005
2010
Year
--------------------------------------------------------~
Sources: Department ofStatistic Malaysia.
The Consumer price index in Malaysia was reported at 111.46 in 2008,
according to the World Bank. The consumer price index (CPI), the main gauge of
inflation to reflects changes in the cost to the average consumer of acquiring a basket
of goods and services that may be fixed or changed at specified intervafs, such as
yearly. CPI to representative that of a group purchases of consumer goods, today more
than ever how much of a time.
The Laspeyres formula 5 is generatly used. Malaysia is a rapidly developing
economy in Asia. Malaysia, a middle-income country, has transformed itself since the
1970's from a producer of raw materials into an emerging multi-sector economy. The
Government of Malaysia is continuing efforts to boost domestic demand to wean the
economy off of its dependence on exports. Nevertheless, exports are particularly of
electronics to remain a significant driver of the economy.
S Laspeyres
formula measures price changes in relation to the base period's market basket and fixes the
market basket by holding the item in it constant.
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Figure 2: The Trend of Producer Price Index in Malaysia, 1970-2010 - - -_._--------------_._ -----_.._ - - ,
Index 160 140 120 100 80 i
60 I
40 I 1
20 ! 0 ~
1970
..,
-1-PPI
I
---.-----r--~--~i .---~---~---r_--~
1975
1980
1985
1990
1995
2000
2005
Year
2010 Sources: Department ofStatistic Malaysia_
The Producer price index in Malaysia was reported at 121_09 in 2008, according
to the World Bank_ The producer price index (PPI), the main gauge of inflation at the
wholesale level. Wholesale price index refers to a mix of agricultural and industrial
goods at various stages of production and distribution, including import duties. The
Laspeyres formula is generally used. Malaysia is a rapidly developing economy in
Asia. Malaysia, a middle-income country, has transformed itself since the 1970s from
a producer of raw materials into an emerging multi-sector economy. The Government
of Malaysia is continuing efforts to boost domestic demand to wean the economy off
of its dependence on exports. Nevertheless, for the exports are particularly of
electronics to remain a significant driver of the economy.
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1.2
Conceptual framework of CPI and PPI
Consumer price index and producer price index are the measurement of
inflation. Policy maker use these two indices to predict future inflation. Inflation is
continuing rise in general price level. Besides, inflation is related to different level of
price because different price affect different people. Wherefore, consumers purchase
goods and services based on their affordable. Different level of income win purchase
different level of price goods and services.
Producer price index in measure of inflation show that increase in the PPI can
resulting increase in CPI. Producer price inflation defines that pressure put on
producers by the costs of their raw materials. This will cause to consumer price
changes. For example, when the price increase on raw material this will cause to
consumer price increase on the finished good. With this, producer could be "passed
on" as consumer inflation and absorb by profit or offset by increasing productivity.
Typically, PPI higher prices mean increased business, it will lead to increased
corporate profits; but if the lower price transmission adverse or highly competitive
market, the PPI is higher competitive field means that many companies wi n face
increasing cost pressures, thus affecting corporate profits, the operational stability of
the entire economy will be tested.
Researcher Jones (1986) have proven on his study, changes in producer prices
lead or cause consumer prices as a result of changes in producer prices which are
passed on to consumers. From Jones (1986) concept, when producer prices changes
causaUty consumer prices change. Besides, from the Keynesians theory, it tends to add
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a capital goods or asset price inflation to the standard measure of consumption goods
inflation. This theory shown, producer price inflation can lead consumer price inflation.
Producer price index is differs from consumer price index. Wherefore, the two
indices are similar in fashion. Change in the PPI will forecast a change in the CPI.
However, when the CPI show a change of a significantly different direction compared
to the PPI. The reason is the different of definition and uses of the two indices. PPI is
use to reduce the revenue streams to get the real picture of output, while the CPI is to
describe changes in the cost of living. Because of those differences, each uses prices
from a different set of products and services.
PPI and CPI is the difference in the timing of data collection. PPI uses primarily
a mail survey to respondents on a monthly basis. In contrast, the CPI collects price
from telephone or personal visits by BLS representatives to respondents do not return
PP I survey fonus on a timely basis, indexes reflect late reports and price corrections.
PPI indexes are considered final. When PPI indexes are first released, they are
typically based on a substantial portion of the total number of prices that will
eventually be received from respondents; hence, subsequent revisions are normally
minor while CPI does not routinely revise indexes.
On the other hands, PPI targets the price of goods on a specific date while CPI
prices are typically collected by the first 18 working days of each month. When a
pricing decision occurred it is possible that it would be reflected in the CPI prior to the
PPI. Prices for some product and service categories in the CPI are collected every
other month. Because CPI reflects the price movement for some items period. In the
PPI, all price quotations are collected monthly.
9
The conceptual and definitional distinctions of the PPI and CPI are consistent
with the uses of these two major economic indicators. The PPI is used to deflate
revenue to measure real growth in output in the economic while CPI is used to adjust
income and expenditures for changes in the cost of living. Furthermore, the CPI
includes services, imports, and sales taxes, whereas the PPI excludes them.
Distribution costs are included in the CPI but not in the PPI. Finally, the PPI includes
capital equipment and the CPI does not.
10 1.3
Problem Statement
Malaysia always put an effort to develop the economy, social, human rights,
ecological integrity and achievement of equity in order to achieve Vision 2020 6 .
Malaysia aims to become a developed and industrialized country by 2020.
The CPI has an extremely important social and economic significance, CPI
stable, full employment and GOP growth is often the most important socio-economic
objectives. The role of consumer price index (CPI) is more important significantly for
the development in Malaysia for the capital market. High inflation wi ll lead to
unoertain earnings prospects of listed companies to increase market risk. The majority
of investors in the capital market sources of funds, their cost of capital are expected to
depend largely on CPI. Rising CPI also often leads to the central bank to raise interest
rates, tightening money supply, reduce the money supply and other measures to
tighten monetary policy, which flow into reduction of capital stock funds for greater
returns, often accompanied by high inflation and therefore the stock market decline.
Besides that, producer price index (PPJ) is a significant factor to increase
Malaysia economic performance and to stimulate economic growth. Nowadays,
Malaysia had spent a lot on infrastructure, public goods and services, capital
investment and social facilities in term of short-term, medium-term and long-term
planning. It is represented that there is an interrelationship between consumer price
index and producer price index.
Vision 2020 is the nation to achieve a self-sufficient industrialized nation by the year 2020 by consider
under all three of the economic, social and environmental factors.
6
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However, there are still remaining several problems, which keep unsolved.
Although the variables are correlated with GOP growth in Malaysia, but will the
further growth of consumer price index and producer price index will benefit GOP
growth in the short term and long term period. Consumer price index tends to spent
more on the operating and development towards the increasing trends for GOP in
Malaysia. Moreover, the producer price index had performed unsteady since 1970.
The producer price index was registered downturn trend for several years. Thus, it is
important for researcher to examine the relationship between consumer price index
and producer price index in order to causality both in the short-run and long-run.
12 1.4
Objective of tbe researcb
The general objective of this research is to examine the relationship between
consumer price index (CPI) and producer price index (PPI) in Malaysia for the year of
1980-2007.
The specific objective of this study:
1. To examine the short-run relationship between the dependent variable (consumer
price index) and independent variables (producer price index)
2. To examine the long-run relationsh i.p between the dependent variable (consumer
price index) and independent variables (producer price index)
3.
To examine the causality pattern between dependent variable (consumer price
index) and independent variables (producer price index)
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I.S
Significance of the Study
Towards achieving the Vision 2020 to become a developed nation, Malaysia
has invested heavily in all dimensions, include fully developed in terms of national
and social unity, economy, social justice, political stability, system of government,
qual ity of life, social and spiritual values, national pride and confidence.
From the study, it might benefit to the policy makers in the decision of making
process. A good management on macroeconomic variables might bring to the
economic growth rather than economic recession.
Thus, this study tends to analyze the understanding the link and relationship
between consumer price index and producer price index in Malaysia. By determining
the independent variables, the main variable wilt be pointed out to explain the major
contributor for short-run and long-run causality between consumer price index and
producer price index in Malaysia. Besides, these two indices are measurement of
inflation. It would be helpful and benefit for policy makers, analysts, traders and
investors to predict future inflation. This significance factor plays an important role
and indicator because it will bring fong-run effects in Malaysia. It might provide a
suitable guiding for government to better understanding on Malaysian economy.
This study also has the potential to determine the growth of GDP in the future
and finaUy will lead to the rapid economic growth in Malaysia. It also help the future
researchers to do further study that related to the economic growth and development in
Malaysia. The CPI and has an extremely important social and economic significance,
CPI stable, full employment and GOP growth is often the most important socio­
economic objectives.
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1.6
Scope of Study
This research reveals the various definitions of CPI and PPI, background
historical and differs of CPI and PPI. More specifically, explore the conceptual
differences by various researchers. This research is to evaluate the links between CPI
and PPI by applying unit root test, test of cointegration and granger causality which
are becoming are more popular. It would be helpful and benefit for investors, analysts,
researcher and government of Malaysia to predict future trend of CPI and PPJ.
Furthermore, the research is to help investors, analysts, researchers and government of
Malaysia to know effect on CPI and PPI.
In additional, CPI and PPI are important to more accurate, reliable and credible
measure especially when the rate of inflation needs to be monitored. It will be
conducted to ensure that the scope and coverage of the indices continue to meet the
needs of users; the structure of the indices reflects the current activities of the industry
concerned; and the weights used continue to be representative of the industry
concerned.
15 1.7
Organization of Chapters
This research is organized into six chapters. Chapter one provides a brief
introduction to the research including the trend of CPI and PPI, conceptual framework
of CPI and PPI , problem statement, research objective, significance of study and
scope of study.
Chapter two of this research will defines about the literature ofCPI and PPI by
various researchers. Differential between the CPI and PPI, theoretical framework, and
hypothesis will be included.
Chapter three will discuss about the data and methodology use in this research.
First section will explain about the research method in this research. The result will
obtain from the data analysis. The data analysis process and methodology shall be in
link with the hypothesis presented in chapter two. Secondary data will through by the
e-view to procedure for gathering data in second section.
Chapter four intends to show the overall finding and empirical result of the
research.
Chapter five contains the discussion, conclusion, recommendations and
implication of research. Strength and potential limitation of the research is included.
Besides, it also provides introduced direction for the future research final of this
chapter is the conclusion of overall research.
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