Index of Industrial Production: Deflation vs. Volume Extrapolation 13 December 2011 UNSD, New York

IIP Main purpose to provide a measure of short term changes in value added However, it is difficult to collect high-frequency data to accurately measure value added Therefore, gross output measures are more commonly used – Value of production & turnover Describes the changes of the volume of goods and/or services produced over time. 2

Laspeyres At individual product level Laspeyres volume index Paasche volume index 3

Laspeyres At aggregated levels, the formula uses indices 4

Laspeyres with Deflator To turn Value (price x quantity) into volume: 5

Deflation Example 1.Preprocessing 2.Value relatives (product) 3.Value indices (product group) 4.Value indices (class/industry) 5.Deflation 6.Volume indices (higher levels) 6

7 Products Product Groups ISIC Levels

8 Products, product groups, ISIC classes ISIC ClassProduct GroupProduct 1511G1 – LeatherP1 – Chamois leather G2 – FurskinsP2 – Dressed furskins 1512G3 – LuggageP3 – Leather suitcase 1520G4 – Leather footwearP4 – Men’s shoes with leather uppers P5 – Women’s shoes with leather uppers G5 – Textile footwearP6 – Shoes with textile uppers G6 – Sports footwearP7 – Ski boots P8 – Tennis shoes P9 – Men’s running shoes

9 Products, product groups, ISIC classes ISIC ClassProduct GroupProduct 1511G1 – LeatherP1 – Chamois leather G2 – FurskinsP2 – Dressed furskins 1512G3 – LuggageP3 – Leather suitcase 1520G4 – Leather footwearP4 – Men’s shoes with leather uppers P5 – Women’s shoes with leather uppers G5 – Textile footwearP6 – Shoes with textile uppers G6 – Sports footwearP7 – Ski boots P8 – Tennis shoes P9 – Men’s running shoes

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11 1. Preprocessing a. Variables b. Weights c. Deflators – PPI at industry levels

12 1. Preprocessing Variables ObsProdPrd GrpISICValue of output T0T0 T1T1 T2T2 1P4G P4G P4G P4G

13 1. Preprocessing Weights Obtained separately for the whole product group from other sources (e.g. structural business survey, economic census) ProductProduct GroupAbsolute weightRelative weight P4 G P Product GroupISIC classAbsolute weightRelative weight G G G

14 2. Value relatives at product level Value relative of product j in period T i Value data of product j in period T i (i=0,1,2) In other words: Value relative of a product at time t is its value at time t divided by its value at time 0

15 2. Value relatives at product level Product [1][2][3]=[2]/[1][4][5]=[4]/[1] P P

16 3. Value indices at product group level Value index of product group k in time t Weight of product at time 0 * value relative at time t In other words: The product group value index is the weighted average of value relatives in that product group

17 3. Value indices at product group level T1T1 T2T2 Prod /Prd Grp Prod weight Prod value relative Weighted prod value relative Prod group value index Prod value relative Weighted prod value relative Prod group value index [1][2][3]=[1]*[2][4]=sum([3])[5][6]=[1]*[5][7]=sum([6]) P P G

18 3. Value indices at product group level Prd GroupISICProduct group value index G G G

19 4. Value indices at industry (4-digit ISIC level) Value index of class k in time t Weight of product group at time 0 * value relative at time t In other words: The industry value index is the weighted average of the value indices of the product groups in the industry

20 4. Value indices at industry (4-digit ISIC level) T1T1 T2T2 Prd Grp/ ISIC Prd Grp weight Prd Grp value relative Weighted prd grp value rel. ISIC value index Prd Grp value relative Weighted prd grp value rel. ISIC value index [1][2][3]=[1]*[2][4]=sum([3])[5][6]=[1]*[5][7]=sum([6]) G G G

21 4. Value indices at industry (4-digit ISIC level) ISICISIC class value index

22 5. Deflation Volume Index = Value index / PPI (at 4-digit level) = volume index in period T i for ISIC class j = value index in period T i for ISIC class j = deflator (PPI) in period T i for ISIC class j

23 5. Deflation ISICProducer Price Indices Deflators (at industry level)

24 5. Deflation T1T1 T2T2 Value index PPIVolume index Value index PPIVolume index ISIC [1][2][3]=[1]/[2][4][5][6]=[4]/[5]

25 6. Volume indices at 3 and 2 digit levels Gross value added at basic prices is recommended to derive weights ISICBase period weight Relative weight (in next higher ISIC level)

26 6. Volume indices at 3 and 2 digit levels Volume index of ISIC group k in time t Weight of ISIC class at time 0 * value relative at time t In other words: The industry value index is the weighted average of the ISIC class volume indices in the ISIC group

27 6. Volume indices at 3 and 2 digit levels T1T1 T2T2 ISIC class/ grp Class weight ISIC class index Weighted ISIC class index ISIC group index ISIC class index Weighted ISIC class index ISIC group index [1][2][3]=[1]*[2][4]=sum([3])[5][6]=[1]*[5][7]=sum([6])

28 6. Volume indices at 3 and 2 digit levels T1T1 T2T2 ISIC grp/ div Grp weight ISIC group index Weighted ISIC group index ISIC division index ISIC group index Weighted ISIC group index ISIC division index [1][2][3]=[1]*[2][4]=sum([3])[5][6]=[1]*[5][7]=sum([6])

29 Summary ISICIIP T0T0 T1T1 T2T

Volume Extrapolation Example 1.Preprocessing 2.Volume relatives (product) 3.Volume indices (product group) 4.Volume indices (class/industry) 5.Deflation 5.Volume indices (higher levels) 30

31 Products, product groups, ISIC classes ISIC ClassProduct GroupProduct 1511G1 – LeatherP1 – Chamois leather G2 – FurskinsP2 – Dressed furskins 1512G3 – LuggageP3 – Leather suitcase, Model A P4 – Leather suitcase, Model B P5 – Handbags, Model A 1520G4 – Leather footwearP6 – Men’s shoes, Model A P7 – Men’s shoes, Model B P8 – Men’s shoes, Model C P9 – Women’s shoes, Model A P10 – Women’s shoes, Model B P11 – Women’s shoes, Model C G5 – Textile footwearP12 – Textile shoes, Model A G6 – Sports footwearP13 – Ski boots, Model A P14 – Tennis shoes, Model A P15 – Men’s running shoes, Model A

32 Products, product groups, ISIC classes ISIC ClassProduct GroupProduct 1511G1 – LeatherP1 – Chamois leather G2 – FurskinsP2 – Dressed furskins 1512G3 – LuggageP3 – Leather suitcase, Model A P4 – Leather suitcase, Model B P5 – Handbags, Model A 1520G4 – Leather footwearP6 – Men’s shoes, Model A P7 – Men’s shoes, Model B P8 – Men’s shoes, Model C P9 – Women’s shoes, Model A P10 – Women’s shoes, Model B P11 – Women’s shoes, Model C G5 – Textile footwearP12 – Textile shoes, Model A G6 – Sports footwearP13 – Ski boots, Model A P14 – Tennis shoes, Model A P15 – Men’s running shoes, Model A

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34 1. Preprocessing a. Variables b. Weights

35 1. Preprocessing Variables ObsProdPrd GrpISICUnitQuantity of output T0T0 T1T1 T2T2 1P3G31520Num P4G31520Num P5G31520Num

36 1. Preprocessing Weights Obtained separately for the whole product group from other sources (e.g. structural business survey, economic census) ProductProd GroupAbsolute weightRelative weight P3 G P P Prod GroupISIC classAbsolute weightRelative weight G

37 2. Volume relatives at product level Volume relative of product j in period T i Volume data of product j in period T i (i=0,1,2) In other words: Volume relative of a product at time t is its volume at time t divided by its volume at time 0

38 2. Volume relatives at product level Product [1][2][3]=[2]/[1][4][5]=[4]/[1] P P P

39 3. Volume indices at product group level Value index of product group k in time t Weight of product at time 0 * value relative at time t In other words: The product group volume index is the weighted average of volume relatives in that product group

40 3. Volume indices at product group level T1T1 T2T2 Prod /Prd Grp Prod weight Prod volume relative Weighted prod vol relative Prod group volume index Prod volume relative Weighted prod vol relative Prod group volume index [1][2][3]=[1]*[2][4]=sum([3])[5][6]=[1]*[5][7]=sum([6]) P P P G

41 3. Volume indices at product group level Prd GrpISICProduct group volume index G G G G G G

42 4. Volume indices at industry (4-digit ISIC level) T1T1 T2T2 Prd Grp/ ISIC Prd Grp weight Prd Grp volume relative Weighted prd grp vol relative ISIC volume index Prd Grp volume relative Weighted prd grp vol relative ISIC volume index [1][2][3]=[1]*[2][4]=sum([3])[5][6]=[1]*[5][7]=sum([6]) G G G

43 4. Volume indices at industry (4-digit ISIC level) ISICISIC class volume index

44 5. Volume indices at 3 and 2 digit levels Exactly the same way as the the deflation example because they are both in volume terms at this point

Recap Data Requirements – Product values (deflation) or quantities (vol. ext.) at current period – Weights at the product, product group and class level Quantity and Price at base period – PPI (deflation) Reflects quality changes Difference in results – Deflation -> Paasche index != Laspeyres index 45

46 Recommendations Deflation vs. Volume Extrapolation Deflation preferred over volume extrapolation Deflation is recommended because: – Better accommodates heterogeneous product mix – Makes use of the price index collection Quality issues already accounted for in PPI Volume extrapolation is easier to use for measuring industries producing homogenous goods with constant quality

Thank you. Questions?