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

Car prices soared after coronavirus lockdowns, and two years after America's worst inflation episode since the 1980s, the industry is showing that recovery will be a long and winding road.

In 2021 and early 2022, global transportation issues, semiconductor shortages and factory closures, coupled with strong demand, have driven vehicle prices skyrocketing. Economists hoped prices would fall as supply chains healed and the Federal Reserve's rate hikes deterred borrowers.

Instead, new car prices continued to rise. Domestic automakers are producing fewer and fewer cars and are focusing on more profitable luxury models. Used car prices helped bring down overall inflation late last year, but rebounded in April as a lack of supply collided with an increase in demand.

"Inflation will not be a smooth decline - 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."

Increased car prices turned out to be unpleasantly sticky. Used car prices have fallenmore quiet - and ephemeral- in fashion than economists predicted. And new cars continue to rise in price this year as manufacturers scramble to keep the margins set in 2021.

“The big question now is: will companies start to compete with each other on price?” Mrs. Uruci asked.

But it is difficult to answer this question because the car market has changed drastically. To understand the situation, it is worth looking at how the automotive industry used to work.

“Going into the pandemic, the dynamic in the automotive industry was that retail profitability was under constant pressure, fueled by the internet,” said Pat Ryan, CEO of CoPilot, a car-buying app that monitors prices at around 40,000 retailers .

Automakers produced more cars than the market demanded, providing incentives to remove inventories and compete with cheaper imports. Dealers profited from volume and funding, which often resulted in customer complaints about fees.

As the coronavirus spreads, factories are shutting down. Even after reopening the semiconductors were still missing. Manufacturers attributed the chips to 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 were never produced, said Mr. Ryan.

Dealers jumped in, charging thousands of dollars above list price — especially as stimulus programs were put in place and consumers wanted to upgrade their vehicles or buy new ones to escape the cities. ONEtesteconomist Michael Havlin, published by the Bureau of Labor Statistics, found dealer margins accounted for between 35 and 62 percent of overall consumer inflation for new vehicles between 2019 and 2022.

Lower sales volumes had their downsides; dealers also make money from service packages many years after the cars are out. But overall, "it was certainly the best time for car dealers," says Mr. Ryan.

Hailey Cote of Pittsburgh found herself in that situation last summer. Tired of low-paying jobs on farms and restaurants, she started a house cleaning business for $25 an hour. When her 2005 Jeep Grand Cherokee broke down, she knew she had to find a replacement quickly so she could haul cleaning equipment to every job and get to school where she was studying counseling.

At the time, the used cars she could find were only a few thousand dollars cheaper than the cheapest new cars, so she opted for a base model 2022 Toyota Corolla. Her loan repayment is about $500 a month. Insurance, which has also become more expensive, costs DKK 200 extra. Including gas and maintenance, Ms. Cote's transportation costs are nearly equal to her rent, leaving nothing for savings or recreation.

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

The car price frenzy began to subside in the second half of 2022 as more vehicles started rolling off the assembly lines. But the supply only increased gradually. Automakers, unwilling to give up profits due to a shortage, started talking about "discipline" in their production targets.

"The experience of higher prices and the ability to change prices broadens the business people's perspective on their options," he said. "It's attractive if you can do it."

One of the ways automakers tried to raise prices was to drop cheaper models like the Chevrolet Spark and Volkswagen Passat. In response to federal subsidies, automakers introduced electric vehicles, but that didn't help drive prices down — they started with luxury versions like the $42,995 Mustang Mach-E.

Added supply constraints. The generation of cars, which typically come with three-year leases, is smaller than usual. Those who leased cars in spring 2020 have an incentive to buy them at the prices that were in place before everything went up.

Moreover, some car rental companies are aggressively rebuilding their fleets after several years of famine, leading dealer groupsjak Sonic Automotivecomplain about talks about earnings that they are outbid at auctions.

"There are so many sources of used vehicles that have just dried up in the last few years," said Satyan Merchant, senior vice president of financial services at TransUnion, a credit monitoring company. "And it all has an end result."

The Fed raised interest rates sharply to curb demand - including for cars - and cool price growth. But during the adjustment period, many Americans find it even harder to afford a car. According to TransUnion, the average monthly payment for a new car rose to $736 in the first quarter of 2023, up from $585 two years earlier. Used cars cost an average of $523 per month, an increase of $110 over the same period.

Competition for vehicles is also fierce at the grassroots level, as those with little financial cushion and personal work can't afford to give up transportation, which in most of the country is synonymous with the car. The job market doesstayed strong, especially for personal jobs in areas such as hospitality and healthcare, so more people have jobs they can come to.

And many people in between, who may switch cars every few years, are waiting for prices to drop.

"What we've seen is the center disappear," said Scott Kunes, chief operating officer of the Midwest dealer group. He blames automakers for ditching cheaper, smaller, entry-level cars that people just need to get around, especially as interest rates make more advanced versions out of reach. "It doesn't make any sense to me."

Soon the situation may begin to resolve itself. Car wholesale prices havestarted to falland car manufacturers offer more incentives. Kelley Blue Book data shows that average prices have fallen below those recorded over the past two months, which Jonathan Smoke, chief economist at Cox Automotive, said this signaled a slowdown in demand. In recent months, the prices of electric cars - the fastest-growing segment of new car sales, although constituting a small part of the overall market - have fallen.

However, recent history has shown that price trajectories are rarely linear. Adam Jonas, an automotive industry analyst at Morgan Stanley, said that in the short to medium term the only answer is to increase inventories.

"Although the Japanese and Koreans say that the shortage of chips is ending, it will take many months," he said. "Retailers should brace for a tough summer."

Reports were contributed by Jack Ewing.