Post #1836: Will used-car prices continue to fall?

Warning: This post contains economics. It’s about the odd state of the used car market, right now. And my guess that used car prices will continue to trend down from their December 2021 peak.

Update one year later, 7/26/2024: At this point, the post-pandemic spike in used-car prices has pretty much run its course. In real (inflation-adjusted) terms, used car prices are only slightly higher than they were before the pandemic. Therefore, I’d guess that there’s not much potential for them to fall much further.

Here’s the updated graph, where I set the index of new and used car prices to a value of 1.0 in January 2020. The underlying data are from the Bureau of Labor Statistics.

Original post follows.

Quality adjustment and the U.S. Consumer Price Index

If you want to get the big picture about a particular market, you start with prices and quantities. What has happened to the prices of new and used cars of late, and how do current prices compare to historical price levels?

You’d think that tracking that would be straight foward, given how important cars are to the U.S. economy. But it’s not. The data as supplied by the U.S. Bureau of Labor Statistics are … hard to interpret. This section is all about the graph below:

Lines: Price index data from the U.S. Bureau of Labor Statistics, via the Federal Reserve of St. Louis FRED system. Columns: Toyota Corolla lowest MSRP from Cars.com, history of the Toyota Corolla.

First, car prices were frozen for three decades? Really? If you take car-price data from the U.S. Bureau of Labor Statistics (BLS) at face value, the nominal (dollar) price of new and used cars remains unchanged for roughly three decades, leading up to 2021. (!) (?) Per BLS, quality-adjusted, the dollar price of a new or used car in 2021 was essentially no different from the dollar price of a car in 1991. Like so:

That must make new and used cars the steal of the century. Because …

Second, over that period, consumer prices in general roughly doubled.

Seems like more than a bit of a stretch to say that the literal dollar prices of cars didn’t change. In fact, I’d be willing to swear that asking prices for new cars, as of 2021, were vastly higher than they were back in 1991.

Using the Toyota Corolla as “a car”, it’s unambiguously true that asking prices have risen. In fact, the asking price — the MSRP — of the base Corolla more-or-less kept pace with overall inflation.

That’s a conundrum. The price of one of the best-selling, mainstream cars in America doubled over that period, keeping pace with inflation. Yet BLS shows no change in the dollar price of the average car, over the same period?

The resolution of this conundrum is “quality adjustment”. Starting in 1987, BLS went all-in on including a quality adjustments in all of its car price data. That means that as cars got better, per the BLS, they effectively got cheaper. That is, a 2021 car is so much better than a 1991 car that, after accounting for that, the raw dollar price of a new car roughly doubled over that period, but the dollar price “per unit of quality-adjusted car” remained constant. And it’s the latter that the BLS uses, and feeds into the U.S. CPI.

The BLS arguably has a point in making this adjustment. And arguably not. Without doubt, modern cars are vastly better than older cars. Safer, faster, more features, long-lived, and to a degree, better MPG. I’m not sure I’ve seen a car with (e.g.) crank windows, or without AC, in a long, long time. A modern car gives you more car than an older car.

OTOH, viewed as a way to get from A to B, car is a car is a car. A base model car today provides roughly the same utility as a base model car thirty years ago.

These days, dollar-weighted, BLS makes such quality or hedonic price adjustments in the majority of the goods and services that make up the CPI. In particular, the adjustment for the quality of computers and other electronics was a long-time contributor to keeping measured price increases down. Every year, laptops and phones get faster and better. BLS interprets that as an ongoing stability or even decline in the price of those goods, quality adjusted.

The important thing for this post is that there’s no big “catch up” in car prices that was due to occur. That’s despite how the BLS car price index data loo. It’s NOT true that car prices were more-or-less frozen for three decades. It IS true that they roughly kept up with overall inflation, assuming the Corolla is representative of “cars” in general. And so we were not somehow “due” for a big catch-up price increase in cars.

Peak used car occurred in December 2021

Source: Analysis of U.S. BLS data for CPI, and new and used cars.

For this next chart, I’ve “inflation adjusted” recent new and used car prices by dividing the BLS indices by the value of the U.S. Consumer Price Index.

The first takeaway is that real (overall-inflation-adjusted) used car prices rose by 40 percent in the year and a half between mid-2020 and the end of 2021.

The second takeaway is that they have been falling, unsteadily, ever since. And now — again, relative to the overall price increases that occurred economy-wide — the real price of a used car is still about 20% above where it was before the pandemic.

Whereas new car prices merely rose in line with overall consumer price inflation.

Just FYI, purchases of new and used vehicles account for about 8 percent of U.S. consumer spending. So there’s a little bit of a tautology in deflating car prices by the CPI, but not a whole lot.

Source: BLS.

Anyway, lest you think the decline in inflation-adjusted used car prices is purely the result of that burst of inflation that we just experienced, here’s the raw index values for the same period, again setting January 2020 to a value 1.0 for both indices.

No matter how you slice it, the price of used cars diverged strongly from the price of new cars, starting in mid-2020. And used car prices have not yet fallen back in line with new-car prices.

Will used car prices continue to fall?

Short answer is, I don’t know. But I’d say the odds are “yes”.

First, in just my little search, it seems like used car prices are soft. Fully realizing that used car dealers list at a high price, and gradually lower it, the asking price for the Leaf I’m interested in is down by about 25% in just over two months. I don’t think that’s typical.

Second, the historical link between new-car and used-car prices held for more than half-a-century. You’d expect to see some sort of return to that long-held ratio of prices.

Third, we’re years past the near-collapse of the rental car market during the pandemic. In good times, the U.S. rental car fleet is between 2 and 3 million cars. And, more to the point, rental companies only hold onto any given car about a year (per this reference). Which means that, in good times, they typically send about 2+ million almost-new cars to the used car markets annually. While that isn’t a huge number (I think there are about 36 million used car sales in the U.S. in any given year), apparently those cars are key to instituting chains of follow-on used-car transactions. (Buyer A buys a used rent-a-car, buyer B buys A’s old car, buyer C buys B’s old car, and so on.)

Source: https://www.discovercars.com/blog/car-rental-company-statistics

As those rental car fleets slowly return to the pre-pandemic level, the flow of used cars from those companies will continue to increase. This should, I think, put further downward pressure on used car prices.