Unraveling Producer Price Inflation Pass-Through : Quantification, Structural Breaks, and Causal Direction

Producer price inflation has long been considered a leading indicator for consumer price inflation. However, the evidence supporting the cost-push theory of inflation over extended periods is inconclusive and lacks direct quantification. To address this gap, we employ structural break and causality tests, regression analysis, and local projection impulse-response functions. Our analysis allows us to precisely identify instances when producer prices lead consumer prices and quantify short-run and long-run pass-through rates. We find fairly robust evidence of a producer price pass-through rate between 7% and 12%. However, there are significant periods where unidirectional pass-through does not hold. Local projections reveal that producer price pass-through is small but persistent in states where producer prices lead consumer prices, and larger but shorter-lived in states where there is no causal directionality. Our findings enhance the understanding of producer price pass-through to consumer inflation, providing valuable insights for policymakers and market participants interested in accurately forecasting and managing inflationary pressures