In a recent speech pointedly titled “Bringing Inflation Down,” Lael Brainard, the Federal Reserve’s vice chair, zoomed in on the automobile market as a real-world example of a major uncertainty looming over the outlook for price increases: What will happen next with corporate profits.
Many companies have been able to raise prices beyond their own increasing costs over the past two years, swelling their profitability but also exacerbating inflation. That is especially true in the car market. While dealerships are paying manufacturers more for inventory, they have been charging customers even higher prices, sending their profits toward record highs.
Dealers could pull that off because demand has been strong and, amid disruptions in the supply of parts, there are too few trucks and sedans to go around. But — in line with its desire for the economy as a whole — the Fed is hoping both sides of that equation could be on the cusp of changing.
data, and several industry experts said they didn’t see a return to normal levels of output for years as supply problems continue. Prices are still increasing swiftly, and dealer profits remain sharply elevated with little sign of cracking.
What the Fed’s Rate Increases Mean for You
A toll on borrowers. The Federal Reserve has been raising the federal funds rate, its key interest rate, as it tries to rein in inflation. By raising the rate, which is what banks charge one another for overnight loans, the Fed sets off a ripple effect. Whether directly or indirectly, a number of borrowing costs for consumers go up.
Ford Motor said on Monday that it would spend $1 billion more on parts than it was planning to in the third quarter because some components had become more expensive and harder to find.
By contrast, the supply of used cars has rebounded after plunging in the pandemic, and prices have begun to depreciate at a wholesale level, where dealers buy their stock. But, so far, those dealers aren’t really passing those savings along to consumers. The price of a typical used car has stabilized around $28,000, up 9 percent from a year ago, based on Cox Automotive data. Official used-car inflation data is easing, but only slightly.
Why consumer used-car prices — and dealer profits — are taking time to moderate is something of a mystery. Jonathan Smoke, chief economist at Cox Automotive, said dealers might be basing their prices on what they paid earlier in the year, when costs were higher, for the cars sitting on their lots.
“Dealers are feeling it,” Mr. Smoke said of the price moderation. “But because they price their vehicles based on what they pay for them, the consumer isn’t seeing the price discounts yet.”
Some early instances of discounting are showing up. At the Buick and GMC dealership that Beth Weaver runs in Erie, Pa., demand for used cars has begun to slow down, and the business has sold a few vehicles at a loss.
rolling lockdowns in China.
The Fed could raise rates so much that it snuffs out demand, but given how much pent-up car-buying appetite exists, Mr. Murphy thinks it would take a lot.
“You probably would have to go farther on rates than they have so far, or even than they are expected to go,” he said. “There may be a point at which you have enough pain that you see a pause on demand.”
If demand continues to outstrip new-car supply and dealers continue to reap big profits, that could limit how quickly inflation will ease. If the mismatch is large enough for sellers to keep pushing up prices without losing customers, it could even continue to fuel inflation.
While the car market is just one industry, the uncertainty of its return to normal holds a few lessons for the Fed. For one thing, new-car production makes it clear that supply chain disruptions are improving but not gone.
More hopefully, the car industry could offer evidence that the laws of economics are likely to reassert themselves eventually. Used-car prices have at least stopped their ascent as inventory has grown, and experts say discounting is likely around the corner. If that happens, it could be evidence that companies won’t be able to keep prices and profits high indefinitely once supply catches up with demand.