Inflation Pressures Vary Significantly Among Small Firms

Although the inflation tax has eased from 9% to the 6% range, that is well above the Federal Reserve’s approved inflation tax level of 2%. It is not likely that inflation will return to the 2% target this year, so the actual tax will be above the target for at least 2023. Chart 1 shows the history of price hikes (net of cuts). The percent of firms raising selling prices is now in reverse from record-high levels, but remains well above the average of 15%. The level of those increasing prices will likely fall slowly throughout the year as inflationary pressures (consumer spending in particular) ease. While the official measures of inflation may show big progress due to declines in large items like cars, gas, and housing, millions of small firms will still be raising prices for some time as they strive to right-size the bottom line, facing less controllable costs like rent and labor costs.

Reports of price hikes in the last few months of the year indicate that inflation was strong, especially in construction, retail, transportation, and wholesale trades. And, 62% of construction firms raised prices on the houses they have yet sell to consumers. Nearly 60% (58%) of wholesale firms raised prices of goods they have yet to deliver to retailers. Retailers will want to pass those costs on to consumers by raising their prices.

With the exception of firms in agriculture and finance, nearly a third (30%) plan to raise prices early in 2023. Firms in the wholesale trades led the “higher prices” parade, with 48% planning price hikes. Plans to cut prices for all firms were scarce (2%), although in the fourth quarter last year 10% reported actually cutting prices. Firms in agriculture experience strong seasonal demand and production patterns, price cutting is often required to unload perishable production. Slowing inflation will not restore lost purchasing power, only slow the loss. Price cuts will be required to restore purchasing power taxed away by inflation.

So, does it matter if a small firm on main street raises selling prices? There are an estimated six million employer firms in the U.S. and many more one person firms (like my plumber and electrician). Government aside (e.g., military and roads and bridges), about half of what consumers buy (2/3 of GDP) is transacted at small firms, especially services. The percent of firms reporting that they raised prices and plan to raise prices provide accurate predictions of future inflation. Using 49 years of quarterly NFIB survey reports of price changing activity, it is clear that there is a strong link between their actions and inflation.[1] Actions taken by small firms on Main Street are drivers of inflation. Dominating the service sector, their price decisions will have a major impact on inflation over the year. Wage pressures will dominate pricing decisions and inflation is likely to be sticky.

[1] The PCE quarterly inflation rate is regressed on the percent of firms raising their selling prices and the percent raising prices by 5% or more. R2 =0.65, PCE = -0.455 + 0.108* % RAISING + 0.069 * % RAISING >5%. Surveys are taken in the first month of each quarter, so January survey data is used to predict inflation in the Jan-March period which is released in April by BLS. Thus, early in February the prediction for first quarter inflation is known.