We recently got two important inflation reports, and together they raise a concern that isn’t getting enough attention.
The Consumer Price Index for August showed that prices increased 3.4% over the past year. But the Producer Price Index, which measures prices for businesses, increased at a much higher rate of 5.4%.
Recommended Stories
This means that while the average consumer is struggling with a 3.4% inflation rate and overall price levels that are about 25% higher than 2020, businesses are dealing with an even higher year-over-year inflation rate of 5.4%.
Moreover, the two-percentage-point difference between consumer and producer inflation rates is highly unusual.
Going back to 2010, typically consumer and producer prices had annual inflation rates that were remarkably close. That makes sense because what producers pay gets passed on to consumers. What stands out today is that the difference between the two is nearly three times what it normally is. So, what does this mean?
One possible explanation is that businesses are absorbing more of their rising costs rather than passing on those increases to consumers. Top of mind for businesses likely are tariff costs and diesel gas costs for transport. Businesses try to absorb price increases in the short term to keep customers, and that can work for a while, but eventually it squeezes profit margins. Businesses then face some difficult choices: raise prices, cut costs, reduce hiring and investment or accept lower profits. And lower business investment is even more likely with Wednesday’s interest rate hike by the Federal Reserve and the expectation of at least two more hikes by the end of 2027.
And that’s where this could become a broader economic problem.
If businesses pass higher costs on, consumers face more inflation. If they absorb them, shrinking margins could mean less hiring and investment. Either way, persistent price pressures can squeeze both sides of the economy simultaneously for producers and consumers.
Given all of this, I see two likely implications for the coming months. One, that these unusually high producer prices will indeed be passed on to consumers more so and that will worsen inflation for consumers. Two, as both consumers and producers buckle under these price pressures, the economy could materially slow down, which will be felt more acutely by low-income consumers and smaller businesses with already tight margins.
And some survey data support this, with many U.S. businesses reporting high operating costs they no longer can absorb.
Tatiana Bailey is executive director of the nonprofit Data-Driven Economic Strategies. Other Gazette articles, TV segments, DDES monthly economic dashboards with technical explanations and how to sponsor their work can be found at ddestrategies.org.
