Total inflation as measured by the price index for personal consumption expenditures (PCE)—known as headline inflation—has slowed in recent months. However, inflation for core services has remained elevated since the first half of 2021. Inflation for food services in particular has been significantly higher than inflation for goods and other services.

These facts and the implications resulting from them are explored in a September 2023 Economic Bulletin by Economist Francisco Scott and Senior Economist Cortney Cowley. They assert that food services inflation has been elevated by the sector’s fast rebound in expenditures and its high dependency on labor amid labor shortages and elevated labor costs.

What should consumers know about the forces that impact the prices they pay for food services?

Strong demand since the pandemic, ongoing labor shortages, and higher-than-average wage growth in the sector all have likely played a role in pushing food services prices higher. On the demand side, we show that real spending on food and beverages rebounded faster to its pre-pandemic trend than spending on other non-housing core services.

The faster rebound might be attributed to the vaccine rollout, pent-up demand for dining out, and the many fiscal stimulus programs during the pandemic recession. Although monetary policy has tightened substantially since the pandemic, and the financial strength of households has started to moderate, spending on food services has remained strong and above its pre-pandemic trend.

With regard to understanding the inflation picture, how important are labor market conditions?

Inflation for food services appears to have become more responsive to labor market shortages than other services. We show that year-over-year inflation for food services and other non-housing core services had a similarly positive—but somewhat weak—relationship with labor market tightness from 2014 to 2020. After 2021, however, when labor markets became severely tight, food services inflation increased faster than inflation for other core services.

Tight labor markets can drive up food services prices by significantly raising restaurants’ labor expenses and reducing their capacity to serve customers. According to the U.S. Department of Agriculture’s Economic Research Service, 75 cents of each dollar spent on food away from home are incurred by food services; the other 25 cents are incurred by food processing, wholesale trade, and other parts of the supply chain. Shortages of workers in restaurants and drinking establishments can be inflationary, as they rely heavily on labor to produce services.

Moreover, the National Restaurant Association estimates that 66 percent of restaurants’ costs are tied to labor and food costs. In 2022 we published a research paper arguing that the price of food and food processing is disproportionately related to labor costs. Conditions in 2023 continued to support that assertion.

What were your conclusions about the relationship between food services and labor?

Food services account for a nontrivial share of non-housing core services to households, and inflation in the sector remains significantly higher than inflation for other core services. A fast rebound in spending and substantial labor market constraints might explain the divergence, because businesses in the food services sector rely disproportionately on labor to produce output. Labor shortages appear to have hindered the capacity of the sector to meet demand for food services.

Ultimately, constraints on labor have led to high wage growth in the sector, high cost pressures, and higher food services prices. Unfortunately, these cost pressures, combined with staffing shortages and other factors, contributed to an uptick in restaurant closures around the region during the second half of 2023. Looking ahead, lowering food services inflation likely will require either a drop in demand for food services, an increase in labor supply or an increase in labor productivity.