The political economy of rising burger prices
I have a friend who is a big burger buff. He went to college in the US, and whenever he would come home for the holidays, he would complain about the price of burgers in Delhi. “You can get a great burger there for less than a dollar, twice this size,” he would say, pointing to the one we used to eat at one of Delhi’s few fast-food joints in the early 1990s.
Last week, he came back from a short trip to New York, completely devastated. “Do you know what a good non-McDonald’s burger costs in New York now?” he asked me. “15 dollars!”
I have read about unprecedented inflation in the US, but this is something else. The last time I ate a burger in New York, nine years ago, I paid $4 at an upmarket cafe. A McDonald’s cheeseburger would have cost me $1, which went up to $1.09 in 2019. In the early 1990s, the same McDonald’s burger would have cost 75 cents. Now, it costs $3.69.
That means the price of a cheap McDonald’s burger had risen at an annual rate of 1.5 per cent over 25 years, and in the past five years, it has shot up by 15 per cent per year! No wonder President Joe Biden’s approval ratings are so bad. The Biden administration desperately needs to cool inflation down or at least control the messaging around it.
One important player in inflation messaging in the US is its central bank, ‘the Fed’, short for Federal Reserve. Every now and then, the Fed or its members make predictions about where they see inflation settling over the next year or so. Based on these inflation expectations, the Fed tinkers with its key interest rate. It also gives people advance notice as to how many rate cuts or hikes are expected over the next few quarters. What the Fed says about inflation is amplified by the media, seeps into party conversations and ends up defining the average consumer’s own view on future prices.
How do interest rates affect inflation? Textbook economics tells us that inflation happens when entrepreneurs want to expand their operations but there aren’t enough workers to work for them. Because workers are in high demand, they ask for higher wages. That pushes up costs, and businesses have no option but to charge higher prices for their products.
The workers have more money in their pockets, but when they go to the shops, they find that everything that they buy has become more expensive: The rise in wages has been offset by higher prices. They now bargain for even higher wages, anticipating that prices will keep going up. This is what textbook economists call a wage spiral. Of course, this is a half-truth. Several studies have decisively shown that periods of high inflation are largely driven by businesses trying to increase their profit margins to make the most of shortages.
In both cases, high inflation is caused by demand for goods and services outstripping their availability. That is why when inflation flares up, central banks try to curb demand. They do that by making loans more expensive. In theory, when interest rates are low, entrepreneurs feel encouraged to take bigger risks, hoping to borrow cheap, spend it on buying machines and hiring more workers, increase production and make more money. The opposite happens when interest rates are hiked: businesses stop investing and cut back on hiring. Workers, faced with a tight labour market, agree to work at lower wages. Both corporate and household demand falls. That brings down prices and inflation eases.
When Covid-19 hit the world, the US Fed quickly brought its interest rate down to 0.05 per cent. This almost free money helped boost the economy and there was a huge surge in employment as soon as the lockdowns ended. However, because of China’s zero-Covid policy and Russia’s war in Ukraine, there were massive supply disruptions.
The average American consumer was earning decent wages and had access to extra-cheap credit, but there weren’t enough things for him/her to buy. Not only did this cause a rise in prices, but also allowed corporates to take advantage of shortages and jack up their profit margins. This is a classic side-effect of easy money. Studies have shown that cheap credit lulls consumers into believing that it is okay for them to borrow and buy things. They assume that they will earn enough to pay off their debts. Inflation is overwhelmingly driven by such credit-fuelled overconsumption.
Easy money in the US caused inflation to hit a 45-year high. It forced the Fed to rapidly raise rates to 5.5 per cent last year. While inflation has cooled off a bit now, the sudden increase in rates has only made the household debt situation worse. Right now, US households have a record $1.1 trillion in credit card debt. An average American’s credit card balance — the amount that is unpaid between two billing cycles — is the highest in 10 years. Similarly, student loans stand at a record $1.7 trillion. Historically, such high levels of household debt have come right before a big recession.
So, the average US citizen is stuck between high prices and equally high debt. This is a terrible situation for Biden just a year away from a possible re-election bid. Democrats know that a lot of this is a matter of optics — how people perceive the inflation situation to be and how confident they feel about paying off their credit card bills.
That is where the US Fed’s latest stance has come to Biden’s rescue. The Fed has suddenly shifted its commentary on inflation and interest rates by saying that it is happy with the way prices have started cooling down. The Fed has also indicated that interest rates will come down to 4.6 per cent by the end of 2024, a year ahead of its previous schedule. That is precisely when Americans will vote for a new President.
The author is a senior economic analyst
