Economists working with price data for the countries of the former Soviet Union have frequently noted the striking difference between the cumulative price increase derived by chaining the reported monthly Producer Price Index (PPI) and the increase over 12 months as reported in the “same month of previous year” version of the same index.
This paper shows that this difference arises from the use of a nonstandard formula that, under the price fluctuations that characterize most transition economies, leads the cumulative price increase derived by chaining the reported monthly PPI to overstate dramatically the rate of price inflation in most of the countries of the former Soviet Union. Although the main focus is on the PPI, it is noted that the problem could also exist for the Consumer Price Index when this index is compiled with the same nonstandard formula.
The analysis is based in part on a seminal paper by Szulc, which studies the problem of drift for a wide class of index formulae, and in part on the observations of price movements made by Fund missions. Greatest during the year 1992, the upward drift declines with slower rates of inflation and, possibly, with changing patterns of price increases, but it is still important for countries such as Russia, where monthly inflation continues to run well into the double digits.
The paper concludes that the chained version of the PPI should not be used as a measure of producer price change and that economists should rather use other deflators or figures based on quantities or volume of production to derive constant price indicators for the countries of the former Soviet Union.