The prices of used cars and trucks are up almost 30% over the past 12 months, contributing a substantial part of the inflation increase – the CPI was up 5% — that has worried investors. Meanwhile, the price index for new cars and trucks rose 3.4%.
Logically, you might not expect such a substantial divergence in the prices of used and new cars. One is obviously a substitute for the other.
But there can be substantial temporary divergences, usually caused by changes in supply and demand. Used car supply normally is a relatively fixed thing, as car owners replace older vehicles with new ones. New car supply is a much more volatile thing, as car makers react to market changes by increasing or reducing production.
Such adjustments are not made instantly, and so a sharp change in demand can have an immediate impact: The largest 12-month decline in prices for new cars and trucks in this century was in 2008, when the beginning of the Great Recession caused sales to collapse.
But then the auto makers cut production and the economy started to recover, restoring market equilibrium.
Now new car production is again being cut, but not because auto makers are reacting to, or anticipating, a plunge in demand. A shortage of semiconductor chips, now as essential as wheels are to a carmaker, has forced a cutback.
That has led to a plunge in supply, and an increase in demand, in the used-car market. Car rental companies, which usually are major suppliers of used cars, have seen rental demand rise as the Pandemic eases, and are reported to be holding on to cars longer and even buying used cars. That has helped to push new car prices up some, and has had a far larger impact on the prices of used vehicles.
The following charts help to show what has happened. Note that, like all CPI figures, prices are adjusted based on quality changes over time. The fact the CPI for new cars and trucks is now only 5% higher than it was in 1999 does not mean that transaction prices for new vehicles are only that much higher than they were when Bill Clinton was in the White House. In addition, the price indexes are based on actual sales, not on list prices. When times are tough, the index for new car prices can sink as the automakers slash the prices they charge rental car companies, even as list prices do not change.
When chip production recovers, new car sales will recover and there will be a reversal in the index for used car prices. Just how soon that will happen is not easy to foresee, but for now the change in car prices should not be seen as a harbinger of a general rise in inflation.