Concern Over Consumer Inflation Is Misplaced: Why Businesses Are Bearing The Real Burden

Last Updated: May 23, 2022

Originally published on by Andrew Duguay, Prevedere Chief Economist.

Inflation continues to be a hot topic in navigating the Covid-19 economy. Media and analyst attention tends to focus on how rising commodity prices will impact the consumer, especially as consumer price inflation is expected to be at above average levels heading into 2022. However, in the current economic climate, businesses will actually bear the biggest burden of inflationary pressure. Here’s why:

Weekly Wages Provide A Buffer Against Inflation For Consumers

Despite rising inflation, there are still signals that the consumer is going to have enough strength to keep spending through the 2021 holiday season.

Consider hourly wages adjusted for inflation. Up until a few months ago, hourly wages consistently stayed above the rate of inflation. When this happens, the consumer has real earning power because people are earning more than inflation is taking away.

However, within the past few months, inflation has increased to more than a 5% annual growth rate, which is uncomfortably high. Within this time period, inflation has risen above hourly wages, resulting in negative wage growth with respect to inflation.

But, the story changes a bit when you look at both how much consumers have saved and the fact that they are working more hours. A look at production and nonsupervisory employees shows that weekly wages were up 5.8% year-over-year in September versus 5.5% for hourly wages, helping to cover the 5.4% inflation rate. This makes sense when you consider the well-documented labor shortage that has resulted in businesses across industries struggling to hire. Many of those who are employed are working longer hours and working overtime, which contributes to higher weekly wages and provides a bit of a buffer against rising inflation. A bigger buffer for consumers is the cumulative $2.5 trillion in excess savings they have amassed since the beginning of the pandemic. Consumers as a whole should be able to draw down this excess savings well past the holiday season.

Businesses Are Left Holding The Bag

While inflation is rising for consumers, businesses are actually absorbing most of the inflationary pressure right now. In fact, the producer price index for commodities was up over 20% year-over-year in September and saw its biggest increase since 1975. Consider this in comparison to the consumer price index, which was up 5.4% on a year-over-year basis.

The producer price index is really just a measure of the cost of goods being passed along the supply chain, from manufacturers to distributors to retailers to consumers. The producer price index for inputs to Stage 1 goods producers (earlier in the supply chain) was up 34.2% in September, while prices received for final demand finished goods were up 11.8%.

In addition to the cost of raw materials required to make their products, businesses also have to factor in labor costs, which given the unprecedentedly tight labor market, are higher than average. A true measure of business cost inflation must account for these compensation costs, and according to a September report from the Bureau of Economic Analysis, compensation was up 1.3% over the past three months compared to last year. Between the increase in the producer price index and the increase in labor compensation, businesses are facing significant challenges.

While many people may just be looking at the stock market and thinking that business conditions are great, many businesses are actually quite challenged with procuring products to keep pace with demand and then trying to pass those costs through the supply chain. Looking ahead, it’s going to continue to be a challenging environment for businesses as many of the supply chain issues are global, which makes the problem harder to solve. The U.S. is importing some of this price inflation, with some of these supply chain constraints coming as a result of shutdowns and lockdowns across Asia and Europe.

Looking Ahead To A Healthy Holiday Spending Season 

This said, consumers are well positioned to have a good holiday season and increase their spending. Consumer sentiment was down a bit in October, with the delta variant certainly being a contributing factor. At the same time, consumers as a whole have a lot of savings, and wages are rising. This buying power is good news, but from the business perspective, this unprecedented level of demand comes with a lot of caveats, as discussed above.

The takeaway for businesses is this: Prepare now to take advantage of a healthy consumer and rising wages this holiday season, being extremely mindful of your pricing strategies along the way to maintain positive margins amid both rising producer prices and labor compensation costs.