By Mike Walden
During the presidential campaign, both major candidates promised to lower prices if elected. Now that the election is over, will President-elect Trump be able to fulfill that promise?
Before I address the question, let me remind you of some important terminology. There is a big difference between “inflation is falling” and “prices are falling.” Inflation measures how fast prices are rising. Hence, as long as inflation is occurring, prices are rising. It’s just a matter of how fast. In the last three years we’ve heard “inflation is falling.” This is correct. In the middle of 2022 prices rose 9.1% compared to the middle of 2021. In the year from October 2023 to October 2024, prices rose 2.6%. Importantly these inflation rate numbers are based on all prices, including food and fuel.
Have we had periods of time when most prices fell? Yes we have, during the 1930s, the late 1940s, the mid-1950s, and most recently in 2008-09 and in early 2020. What do these time periods have in common? They were all years when the economy was in a depression (1930s) or a recession (other periods). During the times when prices were dropping, unemployment was rising, incomes were falling, and consumers were buying less.
The real question is whether we can have prices fall during good economic times? One of the keys to answering this question is labor costs — that is, what workers are paid. As prices rise faster, it is understandable for workers to want higher pay so they can afford the higher prices. Especially with the labor shortage during the pandemic, many workers were in a good bargaining position. As a result, percentage gains in worker compensation almost doubled during the main years of the pandemic (2020-22) compared to the two years prior to the pandemic (2018-20). Understandably, workers don’t want to give back these gains even if the prices of nonlabor inputs drop.
We can see the importance of labor costs for inflation by comparing price trends for services and for products. Labor costs are very important for services, where they account for almost a third of total costs. The share of labor costs for making products is much lower, at 10% to 15%, due to the greater use of machines and automation. This difference makes it financially easier for companies making products to slow their price increases, and maybe even reduce them, when the prices of nonlabor inputs slow or drop.
This difference can be seen in the recent inflation rate data for products and for services. The latest consumer price numbers show product prices fell 1% during the year from October 2023 to October 2024. In contrast, prices rose almost 5% for services during the same year. So right now, the relative bargain is buying products instead of services.
What about the claim of “price gouging” as a tactic used by businesses to keep prices high even when their costs are falling? This claim has particularly been issued against grocery and supermarket prices that most consumers track on a weekly basis.
In evaluating the claim of price gouging, there are a couple of important facts to realize. First, wholesale prices (what the retailer pays) for any commodity tend to be much more volatile than the prices charged to consumers. Second, studies tracking the patterns of wholesale prices paid by food stores and the retail prices of those same products sold to consumers are very similar. This means the ups and downs of wholesale and retail prices move in a very similar pattern.
There is also the argument that the key to lowering prices is lowering energy costs. But while energy costs are certainly important to both producers and consumers, energy costs for both the average household and average business are between 8% and 10% of total costs. Certainly there are many households and businesses that pay a much higher share of their total expenses in energy, and energy is definitely a key component to almost everything we do in the economy. But if energy prices were the main determinant of inflation, we would already be seeing falling prices because both oil and gas prices have been dropping since the past summer. Energy costs help determine inflation, but they’re not the only determinant.
The big question is, if prices do not fall to prepandemic levels, how will households’ standards of living recover? The answer is it will happen when household earnings rise enough to compensate for the higher prices, thereby restoring people’s purchasing power. Fortunately, households are getting close. The latest data show average household weekly earnings have increased 2% less than consumer prices since early 2021. However, a year ago the gap was 5%. So households are getting close to being able to buy what they did prior to the takeoff of inflation.
Here’s the major takeaway. Prices typically don’t drop in good times. Instead, they decline in bad times, mainly in recessions and depressions. Obviously, sending the economy into a downward spiral is not a solution that helps households and businesses. An alternative solution is to have inflation moderate to a reasonable rate that allows the average person to keep up with prices by receiving sufficient pay raises. This has happened in the past. With the annual inflation rate in the mid 2% range and the typical yearly pay raise of near 4%, we may be close to a solution. But, you decide.
Mike Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.
- Categories:
