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michael barbaro
From “The New York Times,” I’m Michael Barbaro. This is “The Daily.” [MUSIC PLAYING] Today, in its aggressive campaign to lower inflation, the United States government is running up against a stubborn obstacle — companies that keep raising prices. My colleague, Jeanna Smialek, has been studying the problem and how it’s been playing out in one of the country’s largest industries, the car market. [MUSIC PLAYING] It’s Thursday, October 6. Hey, Jeanna.
jeanna smialek
Hey, how are you?
michael barbaro
Hi. I’m very sorry for being late. I’m not much of a host if you can’t be on time, huh?
jeanna smialek
No, it’s nice to see you in person.
michael barbaro
[INAUDIBLE] I’ll just wash my hands. I got one of those fancy cups of coffee next door, and they didn’t put enough milk in. You know, this is really not relevant. But do you find it fascinating as someone who studies consumer behavior that oat milk has just completely won out over all the other milks? Like, there was an almond phase. There was a soy phase. And then like, I feel like oats just blew them away.
jeanna smialek
Well, so it was like the OG prophet gauger, right? There was a minute there where oat milk was super expensive because there was only one producer.
michael barbaro
Yeah, it was like a pre-pandemic scarcity issue.
jeanna smialek
Yeah, it trained us all to be ready for this.
michael barbaro
Very much so. All right, should we get started?
jeanna smialek
Yeah, let’s do it.
michael barbaro
OK. Jeanna, just to orient everybody, at this point in the ongoing conversation that you and I have been having about the scourge of inflation in the United States, we’re at the stage where the Federal Reserve keeps taking out its biggest, heaviest tool, higher interest rates, and a little bit like a hammer, slamming it over the head of the economy every couple of months, hoping that by making the cost of borrowing money more expensive, it will slow spending and therefore, bring down prices and reduce inflation. So how is all of that hammering going at this point in the process?
jeanna smialek
It’s not going great, at least so far. So just like you said, the Federal Reserve has this one tool to slow down inflation. That’s interest rates. They have been raising interest rates quite a bit this year, five times in total, with three really big rate increases in order to make it more expensive to borrow and spend money with hopes of slowing down consumer demand. The idea is that if you slow down consumer demand, supply is going to outstrip demand. And when that happens, prices either fall, or at least they climb a lot more slowly. That’s how you get slower inflation.
michael barbaro
Right.
jeanna smialek
And so this is the Fed’s recipe for cooling off the economy, bringing inflation down. Unfortunately, for all of us and for the Fed, that process takes a while to play out. The Fed raises interest rates, but it’s not the case that inflation just comes down tomorrow. It’s a process that has to trickle out through the economy. It sometimes takes a year, two years to fully work. And so what we’re seeing now is that although the Fed has carried out what is really the most aggressive rate increase cycle since the early 1980s, we haven’t actually seen inflation start to slow in a big way yet. It’s moderating a little bit. But it’s still painfully high, sort of top of mind for pretty much all consumers in America.
michael barbaro
OK. And what’s your understanding, as somebody who covers the Federal Reserve, about why this hammer is not doing its job, why inflation remains so unusually high despite five rate increases?
jeanna smialek
So right now, one big factor that’s making this take a while is that the companies who set prices are really reluctant to stop increasing them quickly.
michael barbaro
And why is that?
jeanna smialek
A simple way to think about this is that companies got used to being able to charge quite a bit more.
michael barbaro
Kind of addicted to raising prices?
jeanna smialek
Exactly. I think that’s true. And they’re addicted because this has been really good for corporate profits. Profits, obviously, are the difference between how much you can charge and how much your costs are. So what we saw in sort of this mid-pandemic era is that as companies faced rising costs, because supply chains were all messed up and factories were shut down amid the pandemic, they started to pass those along to consumers.
michael barbaro
Right.
jeanna smialek
They pretty quickly realized that consumer demand was so strong that they could actually pass quite a bit more than just those costs onto consumers. They could charge a lot more than their costs had increased. And so what we saw was that corporations were actually pocketing quite a bit more profit off of this. This was a good period for them. The reason demand was so strong is because consumers both have been stuck at home for months just saving money, and they’d gotten repeated checks from the government.
michael barbaro
Right.
jeanna smialek
Then as they came out of lockdown and started to get jobs and started to change jobs, they got pretty decent wage increases. And so all of that fueled the sort of very solid consumer demand the corporations have really been taking advantage of. And so what we’ve seen over the last two years is that corporate profits have been really solid. Companies like GM, Costco, Ford, John Deere — these household names that of — they are all still taking home abnormally large profit margins.
michael barbaro
But you know what’s surprising about that is that by now, all those government checks you just mentioned to stimulate the economy are presumably spent. The pandemic supply chain issues are more or less resolved. And the Federal Reserve, as we just talked about, is making borrowing money more expensive. So shouldn’t that lead companies to have to lower prices when taken together?
jeanna smialek
Right. You would think that. Because like you said, supply chain issues are improving. They’re not 100 percent cleared up yet, but they’re getting there. And there are several things that should be holding down consumer demand — the Fed’s moves, slow wage growth relative to inflation, and the fact that all of that government help is very much in the rear view mirror at this point. But what we’re seeing is that consumers are still spending out of saving. And so while their consumption isn’t growing as quickly as it was and hasn’t been as robust as it had been, it’s still pretty strong relative to what was normal in say, 2019. And so what we’re seeing is that companies, who have gotten very used to these fat profits, are, at least for the moment, trying to protect them. They’re trying to hang on to those big profits. And so they’re still putting up prices very rapidly as they do that, even in instances where their own costs are starting to fall as those supply chains heal.
michael barbaro
Right. Which means they’re making even more money.
jeanna smialek
Exactly.
michael barbaro
So that would seem to lead us to the conclusion if companies can still do this, and consumers are still willing to pay those higher prices, that Americans turn out to be less price sensitive than perhaps, we had imagined. Because when companies keep raising prices, even in the absence of so much higher demand, we, the consumer, keep paying those higher prices.
jeanna smialek
It does seem to be that is the case. And I think that we’re also just seeing an era of upheaval in the economy. You know, the pandemic changed a lot of things. I think it’s just taking time for all of those changes to sort of settle out. You’re seeing people who, for example, couldn’t buy a car or couldn’t buy a house or couldn’t buy the TV set that they wanted, maybe place more value on those things, be willing to pay more for them temporarily. And I think the question that economists are asking is, does this pricing power that companies have now last? And I think that’s a huge mystery in the economy and a big mystery related to inflation.
michael barbaro
OK, so the situation that this leaves us in is that the Federal Reserve needs to break an addiction that both companies and consumers are feeding. And the best way they can do that is by lowering this hammer over and over and over again until enough consumers scream, uncle, and stop buying all the things we’re talking about, and companies get the message that they have no choice but to lower prices.
jeanna smialek
Right. That’s effectively the idea. The more you raise interest rates, the more you cool down the economy, the more consumers feel like they don’t have the wherewithal to spend all of this money, the more companies are going to have to start competing for a limited pool of consumers again. And how do you compete? Lower your prices, or you don’t put them up as quickly. And so that is really what the Fed is hoping for. And Fed officials have specifically called out these profits as something that they’re watching. They are hoping to see these profit margins shrink as a sign that it’s working. And a really interesting case study that allows us to probe into what’s happening here is the car market. And it’s a case study that gives us some reasons for hope, but also a couple of reasons for worry. [MUSIC PLAYING]
michael barbaro
We’ll be right back. So can you explain why the United States car market gives us both hope and some worry when it comes to the government’s ability to break this corporate addiction to higher prices and profits?
jeanna smialek
So I think it’s important to give a little bit of background on what happened in this market. So there are basically two markets here, the used car market and the new car market. And both of these markets have just gone on a wacky journey over the course of the pandemic.
archived recording 1 The coronavirus outbreak in China is wreaking lots of havoc on supply chains around the world.
jeanna smialek
We saw supply for cars, new cars in particular, just absolutely dry up as factories shut down —
archived recording 1 General Motors, Honda, and Toyota are amongst others having to delay production.
jeanna smialek
— and as important parts that companies need to build these cars just basically became impossible to find.
michael barbaro
Right, like computer chips.
jeanna smialek
Computer chips, exactly.
archived recording 2 Critical components in everything from PCs to cell phones, refrigerators, to new cars.
jeanna smialek
And so we haven’t had enough cars. If you don’t have enough new cars, you also don’t have enough used cars. And so we had a situation where there were just no cars on lots.
archived recording 3 Look, if you bought a new car last year, you could probably sell it for maybe even a little bit more this year.
jeanna smialek
People would pay basically whatever they could to get their hands on a car.
archived recording 4 Used car prices are up 42 percent in a year. Honk if you’re hoping it’s transitory.
jeanna smialek
Used cars typically, as we all know, the day you drive your car off the lot is the worst day of its life, right?
michael barbaro
Right.
jeanna smialek
It usually is the case that once you’ve purchased a car, it goes down in value, and it goes down in value steadily every year. Well suddenly, as anybody who leased a car recently knows, your dealer was emailing you saying, hey, your car is worth more now. Bring it back, please.
archived recording (steve sedgwick) A lot of people are turning around and getting some really big dollars out of those leasehold agreements, buying out the lease and then selling it on the open market. Not bad if you can get some of that.
jeanna smialek
So we just were in the situation where there were so few cars that everybody was trying to get their hands on them. And instead of depreciating the way they usually do, used cars started to go up in price.
michael barbaro
Fascinating.
archived recording 6 Actually, the auto part of this is a big part of the inflation story. A third of this gain in inflation was just used cars.
jeanna smialek
And so this was a big future of inflation, actually. You can think of it as one of the ground zeros for what we saw happen with inflation in the pandemic era.
michael barbaro
OK, so what happens once the Federal Reserve takes out the hammer, tries to bring down prices to the used car market?
jeanna smialek
I think this is why the used car market is the hopeful, or at least “hopeful-ish” part of this story. So when the Fed starts raising interest rates, you do begin to see a pullback in the used car market. Demand for used cars begins to wane. And that makes some amount of sense because if you think about it, used car buyers are fairly price sensitive. Prices are really high as we all know, and suddenly, it costs more to take out a car loan. And so between all of that, it’s become a lot more expensive to buy a car, and fewer people are doing it.
michael barbaro
Right. Because the interest rate, when it goes up, affects all borrowing rates, not just homes, but also the rate you pay to finance your car, to borrow money and pay it back in monthly installments for your car.
jeanna smialek
Exactly. Auto loans are a little bit more expensive. Cars are a lot more expensive. And that combination just makes the affordability equation not work out for a lot of people. And so at a wholesale level, which is where companies go to buy the used car inventory that they then sell to consumers, you do see a rebound in what’s available. And you see wholesale prices for used cars start to come down. So when the used car dealer that you go to purchase a car from is buying its inventory, those prices aren’t as high as they were previously.
michael barbaro
That’s a good sign.
jeanna smialek
That’s a good sign.
michael barbaro
And that relates to in part what the Fed is doing.
jeanna smialek
Exactly.
michael barbaro
But you keep referring to wholesale prices.
jeanna smialek
Right. So this is the complication in this story that I say makes it a “hopeful-ish” rather than a purely hopeful story, because wholesale prices and consumer prices are telling two slightly different stories right now. We’ve seen wholesale prices start to nosedive, which is exactly what you would expect — less demand, more supply, lower prices. But you’ve seen consumer prices basically hold the line. The used car dealers — they’re paying a lot less for these cars at auction. But they’re still charging on average, $28,000 for a used car in America, which is where they reached at sort of the height of the car shortages.
michael barbaro
That’s a lot of money.
jeanna smialek
Right. Exactly. So it hasn’t gone up more, but it hasn’t started to meaningfully come down yet.
michael barbaro
OK. So I need to decode this, because what you’re saying is rising interest rates are doing what they’re supposed to do. They’re lowering demand, which means that the car dealership is paying less for the car. But now you’re saying the car dealer, still addicted to these high profits, is squeezing as much profit out of that lower wholesale price as they can and not passing it on to the consumer. That doesn’t seem like the way this is supposed to work.
jeanna smialek
Exactly. So this is a hopeful story in that supply and demand do seem to be playing out here, but “hopeful-ish” in that it also seems to be taking some time to get the whole way to consumer prices.
michael barbaro
So if that’s the “hopeful-ish” story, what is the worrying component of the car market?
jeanna smialek
So I think the part of the car market that continues to broadcast why this might be a long journey is the new car market. What we’ve seen in the used car market, which is that higher rates and higher costs are sort of bringing supply and demand back in line has not showed up in new cars yet. You’re still seeing pretty big price increases in the new car market. The average new car in America costs roughly $48,000 right now. And new cars are up about 10 percent from a year earlier based on the latest Consumer Price Index Report. And while that’s not the absolute highest rate of increase we’ve seen in the pandemic, it is really high. By way of context, the Fed aims for roughly 2 percent inflation a year. So 10 percent inflation in a good — it’s a very big rate of increase. And so I think the question is, what has gone wrong here? And I think you can kind of break it in two buckets. One is, new car supply remains extremely disrupted, even though supply chains are beginning to heal in many parts of the economy. It’s still really hard to build enough new cars these days. I think the other really interesting thing here is what it says about our divided income spectrum.
michael barbaro
Explain that.
jeanna smialek
One thing that you’ll hear a lot when you talk to dealers in the new car market is that the segment that they just see rip roaring demand from, the people who will pay anything for cars these days, are richer customers. people in the upper-middle income spectrum on up have really amassed a lot of savings over the course of the last couple of years. And they’ve been spending them down only slowly. So they’re sitting on these big cash piles. If they want to purchase a big, fancy new car, they are very much capable of doing that. And they’re much less interest rate and price sensitive than lower income consumers. Because often, they’re buying in cash.
michael barbaro
Right. The interest rate to them means nothing when it comes to buying this car because they’re not borrowing any money to buy it, which is how you would be affected by the rising interest rate. It would be passed on to you in higher monthly cost. That’s not an issue here at all.
jeanna smialek
Exactly. And the other big way that rising interest rates affects consumers is that higher rates trickle through to labor market prospects. Right? If the Fed is raising interest rates, it’s going to slow down the job market. And that makes someone who’s buying a used car, who’s at the lower end of the income spectrum — it makes them less economically secure.
michael barbaro
They might lose their job.
jeanna smialek
Exactly. People who are at the lower end of the income spectrum are much more vulnerable to job loss. People at the upper end of the income spectrum tend to be less vulnerable. And when they do lose jobs, it’s fairly easy to transition. And so I think we are probably seeing a situation where those folks feel a little bit more secure. They have a little bit of savings. And so while this purchase may be a splurge for them, it’s not completely out of the question that they can afford it.
michael barbaro
So just to summarize all this, Jeanna, what’s happening in the used car market is a somewhat welcome scenario for the Fed. Whereas what’s happening in the new car market is not at all a good scenario for the Fed. And if we project this out to the rest of the economy, a larger observation that I’m having is that the Federal Reserve’s policy of raising interest rates to slow spending — it’s kind of regressive, right? I mean, the group of consumers it really hits and hurts and slows the spending of are those who don’t have all that much money.
jeanna smialek
I think that is partially a correct way to think about the Fed’s policies. Fed interest rate increases also affect rich people. Rich people are much more likely to own risky assets, like stocks. And so they can really see their wealth diminish. But I think the kind of day-to-day economic life effects, the, I’m not going to be able to buy a car this year, I’m not going to be able to buy a couch or house or whatever the case may be — those effects are felt most clearly on the lower end of the income spectrum. And so I think you can think of it as regressive in that way. But while interest rate increases and the pain they bring can be regressive, so is inflation. Actually, the car market is a great illustration of this. Used cars got so expensive that poor people just can’t afford them anymore.
michael barbaro
Right.
jeanna smialek
You know? And I think it’s important to note that kind of inflation is very unhealthy for the economy. Poor people in the economy tend to spend a lot more of their income on things they really need, on necessities, on food, on gas, on clothes, on cars to get to work, transportation, et cetera. And as those prices go up quite a bit, it imparts a lot of hardship on those people. And so I think that that’s something to keep in mind as you think about how Fed policy works and what it’s trying to accomplish.
michael barbaro
Right. And of course, if the Fed succeeds in its approach here, it is going to bring those dangerously high inflation numbers down, which means it’s going to meet a lot of these lower income consumers where they are, which is supposed to be healthy.
jeanna smialek
That is the goal. That is the goal. Of course, if you are a lower income consumer who loses their job in the process, it’s not going to feel a lot better to you. But the idea is that inflation affects everybody. And so we do need to have some short-term period of pain in order to bring inflation down. That is how the Fed thinks about this.
michael barbaro
Understood. But, and correct me if I’m wrong here, it seems like a relatively small group of consumers in our economy, better-off Americans, who can live with these price increases and are willing to pay them, as illustrated by the new car market, in some ways can protect a market from the Fed’s efforts to lower inflation by raising interest rates. Is that more or less right?
jeanna smialek
It is clearly the case that richer consumers can be a sustained source of demand and make it harder to wrestle inflation down. It is also the case that they are only part of the market. A lot of consumption happens below those sort of richer groups of people. And so it’s not like these policies are ineffective or that they’re just not going to work because rich people exist. It just might be the case that it is harder to vanquish inflation in a world where rich people have so many savings, where even middle-class people have a lot of savings, and where they’re willing to spend out of those savings.
michael barbaro
So does that mean — to go way back to the top of our conversation — that we are just going to have to stay on this path of taking out the hammer and continuing to raise interest rates? Because we have an economy in which there are plenty of people who turn out to be a lot less sensitive to these price increases than we thought.
jeanna smialek
I think it is pretty clearly the case that inflation is not slowing as rapidly as the Fed had hoped it would. Fed officials are really nervous about how long it’s been high. And so they do plan on continuing to raise interest rates, at least through the end of the year, the beginning of next year, in order to try and sort of tamp down the economy, control these prices. And that could be a pretty painful process. You know, earlier in this process, they talked a lot about a sort of soft landing where the economy could just be set down gently and inflation would slow and everything would be kind of OK. And the window for that is really narrowing. Fed officials themselves will tell you that it’s becoming less and less likely as inflation stays high, because their top priority is really getting those price increases back under control.
michael barbaro
And so if you don’t get a soft landing, you get a hard landing. What does that look like?
jeanna smialek
A hard landing is painful. So in a hard landing, unemployment jumps, and you either have people losing their jobs, or you have people not getting jobs. And people are getting worse raises, no raises, bad outcome. Nobody wants that to happen. Some people think it may be the necessary cost of getting inflation down. But there’s also still some, if small, reason for hope. And that ties back to the profit question that we talked about earlier. The idea is that if corporations start to believe that consumer demand is going to be persistently slower because of all of these rate increases that the Fed has been making, they might actually take a harder look at those profits and say, hey, if I continue to charge more, if I continue to put up my prices, I’m going to start losing customers. And so we might see a situation where companies start to change their behavior, eat into those big profits, and charge lower prices, or put up their prices more slowly. And that would help inflation to moderate and could potentially make it easier for us to achieve that sort of mythical soft landing.
michael barbaro
But they will only do that when they believe they have no other choice.
jeanna smialek
So they’re going to do that if they believe that consumer demand is durably slowing.
michael barbaro
And now it’s just a question of whether they believe that in time for a soft landing. And if you had to say what that window of time looked like, Jeanna, are we talking about weeks, or are we talking about months?
jeanna smialek
Everything in Fed-land kind of happens in months, I would say. But I think that the question is live right now. The Fed has already done a lot of rate increases. It’s clearly signaled that it’s going to do some more. And I think the big question is, does it keep pushing them higher and higher and higher until something breaks? Or does it start to see signs that momentum is slowing and it doesn’t have to do that? And I think that’s a question for probably the next 60 to 90 days.
michael barbaro
Well, Jeanna, thank you. I appreciate it.
jeanna smialek
Thank you for having me. [MUSIC PLAYING]
michael barbaro