Inflation Impact

Inflation Impact

As price increases hit their highest levels in 40 years, Knoxville’s private and public sectors alike scramble to keep pace.

by jesse fox mayshark • February 11, 2022

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(Pexels/Karolina Grabowska)

If you want to understand the effect of rising prices on the restaurant industry, Brian Strutz has a clear illustration.

Demand continues to outstrip supply, pushing up the costs of goods and services.

“A friend of ours opened a restaurant right around 2020 and they bought a deep fryer, and spent $2,500 on that deep fryer,” said Strutz, who co-owns downtown Knoxville’s popular A Dopo Sourdough Pizza with his wife, Jessica. “This person is trying to grow the business and they wanted to purchase another one of the exact same model, and they were quoted $7,200.”

Those numbers aren’t likely to go down any time soon. The federal government reported yesterday that through January, the Consumer Price Index rose by 7.5 percent over the past 12 months — the largest one-year increase since 1982. 

The rising prices come even as other economic indicators remain strong, with consumer spending hitting an all-time high in the fourth quarter of 2021 and the national unemployment rate returning to nearly its pre-pandemic level.

On the plus side, local businesses say, that means demand for goods and services is high.

“Demand has skyrocketed for restaurants, both dine-in and dine-out,” said Strutz, who also leads the Knoxville Independent Restaurant Coalition, which formed last year to represent locally-owned eateries. “Many different operators have had some record-breaking months in the past year.”

But the cost of meeting that demand has risen, too — and is complicated by supply-chain and labor market challenges that have made it difficult to find sufficient materials and employees at any price.

For local hotel operators, supply remains more of a problem than prices, according to Jill Thompson, executive director of the Greater Knoxville Hospitality Association. 

“We were kind of the first ones that were hit by the supply chain disruptions,” Thompson said. “We’re always upgrading and remodeling and ordering linens. And it's continued to be an issue with the new builds, trying to get product, your carpets, your beds and dressers.”

Labor costs are up significantly for hotels, she said, with wages rising 20 to 30 percent in order to stay competitive and attract workers. “We don’t see that moving at all, unless it goes up,” she said. “Once you give somebody a raise, it’s hard to take it away.”

What’s Going On?

Donald Bruce, the Douglas and Brenda Horne Professor of Business in the Haslam College of Business at the University of Tennessee, said that in the simplest terms, the surge of inflation is a mismatch of supply and demand. 

Spending has remained strong throughout the pandemic, buoyed in part by stimulus checks and federal relief packages, and manufacturers and supply chains have struggled to keep up.

“Our economic growth has been quite strong,” Bruce said. “But what we’re finding is the demand side of the economy is growing much more quickly than the supply side.”

He said Thursday’s monthly report, which showed even higher inflation than many economists had predicted, was not surprising: “These numbers are a manifestation of what we’ve been feeling for quite some time.”

That includes a power shift in the labor market, as workers find themselves in their strongest position in years. Employers are competing for employees, pushing up wages after years of low growth coming out of the 2008 recession.

Although the inflation surge has lasted longer and risen higher than some economic forecasters predicted last year, Bruce said expected interest rate increases by the Federal Reserve in coming months should begin to rein it in. 

“I don’t anticipate that this is the first year in a longer period of higher inflation in the United States,” he said. “This is largely pandemic driven, and the extent to which we emerge from that situation will continue to help the economy stabilize.”

In the meantime, many businesses will probably have to make choices about whether, when and how to either pass price increases on to customers or modify their operations. As long as demand stays strong, Bruce said, inflation alone is unlikely to presage a recession.

“I think it’s safe to say it’s not an existential threat to businesses in general,” he said. “But it is a threat to business as usual.”

Making Adjustments

That’s certainly true for restaurants, Strutz said. The overall inflation number of 7.5 percent is considerably lower than what many local restaurant owners are seeing for their basic supplies.

“One restaurant downtown who goes through a lot of rice and buns for their steamed buns, rice has gone up 40 percent, buns have gone up 29 percent,” Strutz said. “At our restaurant, flour has gone up 15 percent, tomatoes have gone up 12 percent. We have four different dishwashing chemicals, each individual chemical has gone up a minimum of 17 percent and a maximum of 23 percent.”

Faced with those kinds of increases, restaurants have to decide how much to pass on to customers by way of higher menu prices, and how much to absorb in other ways.

“You buy cheaper ingredients, you cut the portion sizes, or you remove parts of the meal,” he said — for example, offering one side dish rather than two with an entrée. “You have a lot of different options and some operators are getting really clever and they're just cutting their menu down. Maybe they're getting rid of some of those loss leaders that they would serve in the past just to get people in the door.”

One relative bright spot for local restaurants is that many of them try to buy as much local meat and produce as possible — and goods coming from farms in Knox and surrounding counties have not been affected by supply-chain shortages and price increases nearly as much as those coming from afar.

At the Knoxville Chamber, Vice President for Economic Development Doug Lawyer said he’s heard from member businesses about costs and shortages across the board.

“They’re saying shipping costs are going through the roof, everything related to trade and supply chain. Getting raw materials in via ocean freight is just a disaster right now,” he said. 

One result is that contractors are increasingly limiting their bids to shorter periods, aware that prices might rise if it takes too long for a job to come to fruition. “Those prices are only good for 30 days anymore,” Lawyer said, “where it used to be you could get a cost estimate and feel pretty good about it for much, much longer time frames.”

Clay Crownover, president and CEO of Associated Builders and Contractors of Greater Tennessee, said that’s one of the adjustments builders have had to make to avoid losing money on a job.

“A lot of big contractors are at an advantage, because they have the capability to do the proper market analysis of where they expect things to be when the project starts,” Crownover said. “The smaller companies may not necessarily have that advantage to have somebody that can do that type of work. They may come in at a much lower bid on a project, but then they may be operating at a loss.”

Materials costs continue to drive most of the increases in construction prices, he said. The industry already had relatively high wages before the pandemic, so labor costs haven’t risen nearly as much. But finding enough people to fill those well-paid positions remains a challenge.

“It’s still we face that (question), are you willing to do it?” Crownover said. “And willing to get trained to do it properly?”

Demand for construction services has remained high straight through the pandemic. Knoxville is now seeing some of the same dynamics as Nashville in recent years, he said. “We have contractors that usually only do work in other states and Nashville that are now coming over to Knoxville.”

Not Just the Private Sector

Inflation hits all parts of the economy, including local governments and nonprofit agencies. But their funding streams are often less responsive to price increases than the private sector, creating particular challenges.

“Inflation is certainly impacting our nonprofit sector in a myriad of ways,” Tiffani Mensch, chief capacity building officer for the Alliance for Better Nonprofits, said in an email. “Community needs increase, donations decrease, operating and program expenses rise, and grant dollars don’t stretch as far. Supply chain issues have had a huge impact on local nonprofits’ ability to access essential materials and resources needed to fulfill their missions — for example, the increased cost of lumber puts a huge strain on organizations working in housing and home repair.”

Because nonprofits already tend to pay less than the private sector, the labor shortage is especially acute for them. And they have less ability to raise prices on goods or services to make up the difference.

“Amidst all of this change and uncertainty, it’s important for nonprofits to find ways to adapt and be flexible,” Mensch said. “Diversifying funding streams, collaborating with other organizations, having honest conversations with donors and stakeholders, and staying focused on your mission – these are all things nonprofits should prioritize to stay viable and sustainable long-term.”

Local governments will have to take account of higher costs as they enter their annual budget cycles this month. Chris Caldwell, Knox County’s chief financial officer, said inflation will affect everything from basic office supplies to food at the county jail to the cost of issuing bonds for capital projects.

“If you go to look at revenue bonds now, although the Fed hasn’t raised that (interest) rate yet, it’s already incorporated” in the pricing, Caldwell said.

Governments will also face pressures to increase wages, both to stay competitive with the private sector and to meet the needs of their employees who are facing higher costs for groceries and services.

“If you look at some of the cost-of-living adjustments this year at the state level, they’re at 4 or 5 percent,” Caldwell said. “So we’ve got to keep that in mind as we look at it.”

But the county relies substantially on property taxes for its general budget, and property taxes do not keep pace with inflation the same way sales taxes do. (The majority of sales taxes in the county go directly to fund the school system.) Fortunately, the county is coming off back to back strong years in revenue growth, along with federal pandemic assistance.

Overall, while inflation clearly poses challenges, both private and public employers said they are generally positive about the economic outlook.

“We are an optimistic group anyway,” Thompson said of local hotel owners. “So you just continue on that course. You just figure it out.”