Inflationary pressures vary significantly among small businesses

Although the inflation tax has been reduced from 9% to 6%, that is well above the Federal Reserve’s approved inflation tax level of 2%. Inflation is unlikely to return to the 2% target this year, so the actual tax will be above the target at least for 2023. Chart 1 shows the history of price increases (excluding decreases). The percentage of companies raising sales prices has now reversed from record highs, but remains well above the 15% average. The level of those rising prices is likely to decline slowly throughout the year as inflationary pressures (especially consumer spending) ease. While official inflation measures may show great progress due to declines in major items such as cars, gasoline and homes, millions of small businesses will continue to raise prices for some time in their quest to gauge the bottom line properly, faced with less manageable costs such as rent and labor costs.

Reports of price increases in the last few months of the year indicate that inflation was high, especially in construction, retail, transportation and wholesale. And 62% of construction companies increased the prices of the homes they have sold to consumers to date. Nearly 60% (58%) of wholesale companies increased the prices of goods they have yet to deliver to retailers. Retailers will want to pass those costs on to consumers by raising their prices.

Excluding companies in agriculture and finance, nearly a third (30%) plan to raise prices in early 2023. Wholesale companies are leading the “higher price” parade, with 48% planning price increases. Plans to lower prices for all companies were scarce (2%), although in the fourth quarter of last year 10% indicated that they would actually lower prices. Farming businesses face strong seasonal demand and production patterns, price reductions are often necessary to unload perishable products. Slowing inflation does not restore lost purchasing power, it only delays the loss. Price reductions will be necessary to restore inflation-stressed purchasing power.

So, does it matter if a high street small business raises sales prices? There are an estimated six million employer businesses in the US and many more sole proprietorships (like my plumber and electrician). Excluding government (e.g. military and roads and bridges), about half of what consumers buy (2/3 of GDP) is handled by small businesses, mostly in the service sector. The percentage of companies reporting that they have raised prices and are planning to raise prices provides accurate predictions of future inflation. From 49 years of quarterly NFIB survey reports on price-changing activities, it is clear that there is a strong link between their actions and inflation.[1] Actions by small firms on Main Street are drivers of inflation. Their pricing decisions, which dominate the services sector, will have a major impact on inflation throughout the year. Wage pressures will dominate pricing decisions and inflation is likely to persist.

[1] Quarterly PCE inflation is reduced based on the percentage of companies raising their selling prices and the percentage raising prices by 5% or more. R2 =0.65, PCE = -0.455 + 0.108* % INCREASE + 0.069 * % INCREASE >5%. Surveys are conducted in the first month of each quarter, so the January survey data is used to forecast inflation in the January-March period, which is released by BLS in April. For example, the forecast for inflation in the first quarter is known at the beginning of February.