In our economy, Main Street plays a significant role. The Small Business Administration (SBA) reveals that almost half of our GDP is transacted on Main Street. This means that the pricing behavior of the millions of small businesses, both employer and non-employer firms, has a direct impact on various economic factors, such as the rate of inflation and the cost of the basket of goods used to measure the Consumer Price Index (CPI).
To determine the CPI, the Bureau of Labor Statistics (BLS) sends out thousands of shoppers every month to gather data on the prices of goods and services in the CPI basket. And it's not just large retailers and corporations they visit - they also shop at small businesses in small towns. This is crucial because millions of consumers pay prices that are set by these small businesses.
For over 50 years, the National Federation of Independent Business (NFIB) has been collecting data on price changes from a large sample of its small business members. This data provides valuable insights into inflation trends. Chart 1, based on this data, shows the Personal Consumption Expenditures (PCE) inflation rate predicted by the actions of small firms early in each quarter. With over 1,000 firms reporting price actions in the first month of each quarter, their behavior sets the tone for the PCE inflation rate throughout the quarter.
Interestingly, the data reveals that small business owners have sometimes 'under anticipated' inflation in the past, particularly in the 1980s. However, in recent times, they have tended to over-anticipate inflation, with a significant number of firms raising prices by 10% or more. This information is crucial because the model used by NFIB is based on three survey measures: the percentage of firms reporting price increases, the percentage raising prices by 10% or more, and the percentage planning to raise prices in the coming months. These measures have been found to explain 59% of the variation in PCE inflation, highlighting the significance of small businesses in predicting inflation trends.
When looking at specific industries, wholesale and retail businesses, along with financial services, were most frequently reported as raising prices in January. This is not surprising, as these industries deal directly with managing prices and interest rates. Non-professional services firms also showed a similar trend, benefiting from increased consumer spending and solid job growth. On the other hand, firms in agriculture and wholesale trades cited inflation as their single most important problem, highlighting the challenges faced by these industries.
It is important to note that overall, inflation is not desirable for a healthy economy. The adjustment costs to changing costs and prices are substantial, and the income and wealth redistribution effects are not favorable. Inflation also leads to misdirected resources and distortions in the economy. Price stability is much more desirable, but achieving it requires coordinated economic policies.
Despite the potential negative impacts of inflation, it is important to understand that prices naturally rise over time. Even when inflation eventually falls to the Federal Reserve's 2% target, prices will continue to increase. Unfortunately, for many individuals, wage gains have not kept up with the 18% increase in prices since 2020 according to the CPI. This creates a situation where households may face financial difficulties unless prices start to decline, or their incomes experience stronger growth. While the prices of goods have seen declines, the labor-intensive services sector has not shown significant downward movement in prices. Rising compensation costs continue to put pressure on businesses' bottom lines and the prices they charge to consumers.
As a result, the Federal Reserve is striving to achieve and maintain a 2% inflation rate for a sustained period before declaring victory. However, the performance of Main Street firms will be critical in determining the outcome. These firms 'predict' that inflation will remain sticky, hovering around 4% according to the PCE. The accuracy of these predictions will depend on various factors, including the imputations that drive the PCE index, such as housing expenses and rent.
In conclusion, small businesses on Main Street play a vital role in shaping inflation trends and the overall economy. Their pricing behavior, as reflected in the data collected by organizations such as NFIB, provides valuable insights into inflation predictions. It is crucial for policymakers and economists to consider the impact of small businesses when formulating economic policies to achieve price stability and promote a healthy economy.
