Hutchins Roundup: Inflation, business expectations, and more

Studies in this week’s Hutchins Roundup find that the official CPI might be understating inflation, expectations of lower demand are driving small businesses to delay reopening, and more.

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Inflation may be higher than reported in the official CPI

The coronavirus pandemic has significantly altered consumer expenditures, but official consumer price indices may not appropriately reflect these changes. Using data from US credit and debit card transactions, Alberto Cavallo from Harvard updates the weights on each category in the U.S. Consumer Price Index and finds that the coronavirus-adjusted headline annual inflation rate in April 2020 should be 1.06% rather than the official 0.35%. Consumer preferences and coronavirus-related restrictions limit spending in categories that have been experiencing deflation—such as transportation, dining and accommodations, and recreation—but boost expenditures in food and groceries, where prices have been increasing. Examining 16 other countries, he finds that, using a coronavirus-adjusted CPI, ten have a higher inflation rate than that reported by their national statistical office while in six the adjusted rate is lower.

Post-coronavirus reopening depends on business expectations of demand

Using a nationwide survey of over 27,000 small businesses, Dylan Balla-Elliot of Harvard Business School and coauthors find that many small businesses are delaying reopening by a few weeks—at least 18% will delay reopening by at least a month after official restrictions are lifted. This decision seems to be driven by expectations that demand will be depressed rather than supply chain or health-related concerns. On average, surveyed firms expect that demand for their products or services will be 35% lower in September relative to pre-crisis levels. The authors reason that firms can source materials and services from different suppliers, but they depend on a small group of customers for their sales. Other businesses, in particular, play a crucial role in reopening decisions because they are either customers or refer customers. Businesses providing services in education, food and accommodations and entertainment, and those competing with online retailers expect demand to fall; businesses with older customers and in areas with higher Republican vote shares expect no drop or an increase in demand. Many businesses that delay reopening may close permanently, the authors warn, which will disrupt the economic system for many years.

Housing supply constraints have not been the main driver of high rents

Raven Molloy and Andrew Paciorek from the Federal Reserve Board, and Charles G. Nathanson from Northwestern find that constraints on housing supply have a bigger impact on the purchase price of houses than on housing affordability, measured as quality-adjusted rent. They show that supply constraints such as land availability and zoning regulations increase quality-adjusted rent by only half as much as they increase house prices and the magnitude of this effect is small. For example, a metropolitan area with regulations that are 2 standard deviations more stringent than the average area experienced less than 7 percentage point faster quality-adjusted rent growth over a 35 year period. Supply constraints have no effect on consumers’ choice of neighborhood, and only modest impact on unit size, lot size, structure type, number of rooms, and household size. The authors conclude that supply constraints have not been the only factor responsible for rising rents.

Chart of the week: Retail sales jumped in May as states moved to reopen

Quote of the week:

“In recent weeks, some indicators suggest a stabilization or even a modest rebound in some segments of the economy, such as retail merchandise and motor vehicle sales. Employment rose in many sectors of the economy in May and the unemployment edged down as some workers returned to their jobs from temporary layoffs. With the easing of social distancing restrictions across the country, people are increasingly moving about, and many businesses are resuming operations to varying degrees. At the same time, many households have been receiving stimulus payments and unemployment benefits which are supporting incomes and spending,” says Jerome Powell, chair of the Federal Reserve Board of Governors.

“Activity in many parts of the economy has yet to pick up, however, and overall that put us far below earlier levels. Moreover, despite the improvements seen in the May jobs report, unemployment remains historically high. Weak demand, especially in sectors most affected by the pandemic, is holding down consumer prices. As a result, inflation has fallen well below our symmetric 2 percent objective. Indicators of longer-term inflation expectations have been fairly steady. The extent of the downturn and the pace of recovery remain extraordinarily uncertain and will depend in large part on our success in containing the virus. We all want to get back to normal, but a full recovery is unlikely to occur until people are confident that it is safe to reengage in a broad range of activities.”