Keeping a clunker might no longer make sense

It wasn’t long ago that there was talk about the automobile industry being in a slump that was tantamount to a recession.

But that read didn’t take account for how consumers would respond to soaring costs for vehicle maintenance and repairs, giving car sales a boost that proved to be more than enough to overcome the negative impact of the trade war on the auto industry.

This month’s consumer price inflation report showed that inflation for these services has increased sharply during the past year, with inflation now running at a 3.8% rate, close to the highest levels in a decade and more than two percentage points higher than the broad consumer price index.

This rising cost of vehicle maintenance makes sense. As vehicle quality has improved, consumers have kept their cars on the road for longer, with the average age of the U.S. fleet hitting 11.8 years earlier this year. But even if cars can stay on the road longer than ever, they still need servicing from time to time, and pieces of plastic, rubber and metal wear out and need replacing, particularly with the seasonal temperature swings experienced in the eastern part of the country. The confluence of a lot of older vehicles on the road combined with a tight labor market makes it harder to hire workers to perform these tasks, putting upward pressure on wages that then get passed along to consumers in the form of higher maintenance costs.

On the margin, this may shift the thinking of consumers with old cars. Maybe it’s not worth holding onto a vehicle for a 14th year if it’s going to be more and more expensive to service it. With the cost of financing the purchase of a new vehicle falling amid the recent drop in interest rates, there’s an added incentive to buy new rather than service an aging auto.

Recent retail sales support shows that this may be playing out. Auto sales were a bright spot in August. During the past year, retail sales at motor vehicle and parts dealers have increased by 6.8%, the fastest rate in more than three years.

The past three months of core inflation as measured by the CPI have been elevated, and if it continues, the choices confronting consumers with their automobiles show how rising wage costs feed into consumer prices and can alter behavior. If maintaining older cars gets too expensive we might see a temporary uptick in new vehicle purchases, increasing demand for workers building new cars while decreasing the demand for workers servicing them. By the same token, if going out to eat gets too expensive because of the rising cost of wages in the restaurant industry, consumers can eat at home instead; or they can eat out at establishments that have invested in labor-saving technology.

These behavioral changes would result in an economic environment where growth is driven more by capital investments rather than simply finding more people willing to work more hours. It should ultimately lead to increased capital investment and faster productivity growth. An uptick in inflation from 1.8% to 2.5% would have some categories growing faster than others, with the areas of the fastest inflation growth being ripe for labor-saving investments or substitution toward less labor-intensive economic activities.

These types of substitution effects won’t be as simple to describe as low inflation or high inflation, but will reflect a more nuanced situation. This suggests that the Federal Reserve may not need to aggressively hike interest rates to prevent inflation from accelerating, and that the economy has ways of self-correcting. And if the Fed doesn’t feel pressure to raise rates, the implication may be that there’s room for the economic expansion to run for a while longer.

WPBloom

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