Why is inflation so stubborn? Cars are part of the answer. (2023)

Car prices have soared in the wake of the coronavirus lockdowns and two years after the worst inflationary bout in the United States since the 1980s, the industry is proving that a return to normality will be a long, boring road.

In 2021 and early 2022, global shipping issues, semiconductor shortages and factory closures coincided with strong demand to dramatically increase vehicle prices. Economists had expected prices to fall as supply chains healed and rate hikes from the Federal Reserve would deter borrowers.

On the other hand, prices for new cars rose even more. National automakers continue to produce fewer cars and focus on more lucrative luxury models. Used car prices helped to contain general inflation towards the end of last year, but rebounded in April as a lack of supply collided with rising demand.

"Inflation will not be a smooth downward path - there will be bumps along the way," said Blerina Uruci, chief US economist at T. Rowe Price. "There are so many idiosyncratic factors at play right now, and I think some of them have to do with post-pandemic demand."

Rising car prices have proven to be uncomfortably rigid. Second-hand prices have dropped, but in aquieter - and unstable- fashion than economists expected. And new cars have continued to get more expensive this year as carmakers try to maintain established profit margins in 2021.

"The big question now is, are companies going to start competing with each other on price?" asked Mrs. Urucci.

But this is a difficult question to answer because the car market has changed so drastically. To understand the situation, it's helpful to consider how the automotive industry used to work.

“Going into the pandemic, the dynamic of the auto industry was the idea that retail profitability was under constant pressure, driven by the internet,” said Pat Ryan, CEO of CoPilot, an auto shopping app that tracks prices on about 40,000 dealerships. .

Automakers produced more cars than the market required, providing incentives to clear inventories and compete with low-cost imports. Merchants made their profits from volume and funding, often resulting in customers complaining about excessive fees.

As the coronavirus spread, factories closed. Even when they reopened, semiconductors remained scarce. Manufacturers branded their most expensive models—trucks and SUVs—compensating for lower volume with higher profits on each sale. About five million cars that would normally have been produced never were, Ryan said.

Dealers jumped in, charging thousands of dollars above list price—especially when incentives rolled out and consumers looked to upgrade their vehicles or buy new ones to escape the cities. ONEto studyEconomist Michael Havlin, published by the Bureau of Labor Statistics, found that dealer surcharges accounted for 35% to 62% of overall new vehicle consumer inflation from 2019 to 2022.

There were downsides to lower sales volumes. Dealerships also make money from service packages years after the car rolls off the lot. But overall, "it was the best time for car dealers, for sure," Ryan said.

That's the position Pittsburgh's Hailey Cote found herself in last summer. After getting fed up with low wages at farms and restaurants, he started a house cleaning business for $25 an hour. When his 2005 Jeep Grand Cherokee broke down, he knew he needed to find a replacement quickly so he could haul the cleaning equipment to and from each job to school, where he is majoring in counseling.

At that point, the used cars she was able to find were only a few thousand dollars less than the cheapest new cars, so she opted for a base model 2022 Toyota Corolla. a month. Insurance, which has also become more expensive, costs another $200. Including gas and maintenance, Ms. Cote are almost as much as her rent, leaving nothing for economy or recreation.

"I think basic needs are really the worst," said Cote, 29. "Food has gone up a bit, but the cost of housing, healthcare and cars is brutal."

The car price frenzy started to ease in the second half of 2022 as more vehicles started rolling off assembly lines. But the supply increased only gradually. Automakers, reluctant to give up profits because of shortages, began talking about exercising "discipline" in their production targets.

“The experience of higher prices and the possibility of changing prices broadens the perspective of entrepreneurs in relation to their options”, he said. "It's attractive if you can do it."

One of the ways automakers have tried to raise prices is by dropping cheaper models like the Chevrolet Spark and Volkswagen Passat. In response to federal subsidies, automakers have introduced electric vehicles, but that hasn't helped to bring prices down -- starting with luxury versions like the $42,995 Mustang Mach-E.

And bid restrictions have been added. The generation of cars that would normally be leased for three years is lower than normal. Spring 2020 renters have an incentive to buy them at fixed prices before everything gets more expensive.

In addition, some car rental companies are aggressively renewing their fleets after starving them for several years, leading dealership groupscomo a Sonic Automotiveto complain about winning calls that are overcompeting in auctions.

"There are so many sources of used vehicles that have just dried up in recent years," said Satian Merchant, senior vice president of financial services at TransUnion, a credit monitoring firm. "And everything has that downstream effect."

The Fed has sharply raised interest rates to slow demand - including for cars - and cushion price increases. But during the adjustment period, this makes it even more difficult for many Americans to purchase a vehicle. According to TransUnion, the average monthly payment for a new car has increased to $736 in the first quarter of 2023, up from $585 two years ago. Used cars averaged $523 per month, up from $110 over the same period.

Competition for vehicles is also fierce in the lower segment, as people with little financial comfort and personal jobs cannot do without transport, which in most parts of the country is synonymous with the car. The job market hasshe stayed strong, especially for personal jobs in industries like hospitality and healthcare, so more people have workplaces to commute to.

And many people in between, who might change cars every few years, are waiting for prices to come down.

"What we've seen is the disappearance of the medium," said Scott Kunes, director of operations for a Midwestern dealer group. He blames automakers for abandoning cheaper, smaller, basic cars that people just need to get around, especially as interest rates make higher-end versions unaffordable. "It makes absolutely no sense to me."

The condition may start to resolve soon. Wholesale car pricesstarted to fall, and automakers are offering more incentives. Kelley Blue Book data shows average prices have fallen below list over the past two months, which Jonathan Smoke, chief economist at Cox Automotive, said means demand has slowed. Prices have dropped in recent months for electric cars - the fastest growing segment in new car sales, albeit a small part of the overall market.

However, recent history has shown that price trajectories are rarely linear. Adam Jonas, auto industry analyst at Morgan Stanley, said that in the short to medium term, more inventory was the only answer.

"While Japanese and Korean claims are that the chip deficit is over, it takes many months to overcome it," he said. "Traders should prepare for a tight summer."

Jack Ewing contributed reports.