Amid a recovery, consumers face off against inflation (2023)

Consumers have been at the forefront of the postpandemic recovery, with real consumer spending growing by 12.1% in 2021.1 Sustaining this recovery in the medium term, therefore, depends much on their ability and willingness to raise their purchase volumes. So, it’s worrying to see different moods in two key measures of consumer sentiment. As figure 1 shows, the University of Michigan’s Index of Consumer Sentiment Index (ICS) has been trending much lower than the Conference Board’s Consumer Confidence Index (CCI) since early 2021. That’s unprecedented as the two measures have never given such different signals. Does that mean we don’t really know the pulse of US consumers? Thankfully, that’s not the case. The gap between the two measures is mostly due to inflation and its greater role in the ICS than in the CCI. This leads to a more important question: Does high inflation threaten growth in real consumer spending? The answer is yes. Rising inflation weighs on consumers’ purchasing power by slowing or even reversing gains in real wages and wealth. It often forces households—especially low- and medium-income ones—to pull back on discretionary spending. Worse, any higher-than-expected rise in inflation may force a stronger dose of monetary tightening, further weakening the impetus for consumers to spend. Inflation also hurts low-income households more than others, thereby widening income inequality.

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Inflation clouds consumers’ expectations

The ICS fell to 59.4 in March—the lowest reading in more than 10 years—with inflation dominating people’s worries about personal finances and economic growth. In the survey, expectations about inflation a year from now have edged up steadily since last year, to 5.4% in March. That’s not surprising given that headline inflation went up to 8.6% in March, the highest since the early 1980s. Core personal consumption expenditures (PCE) inflation, a gauge for prices that is tracked closely by the United States Federal Reserve (Fed), was at 5.4% in February and has been above the Fed’s target of 2% since April 2021 (figure 2).

Worries about inflation—as is overwhelmingly evident in the ICS data—do not find their way as much into the CCI, which puts greater emphasis on the labor market. That is a key reason behind the higher numbers for the CCI compared to the ICS. The labor market has been steadily improving since the deep shock in the first half of 2020 when the pandemic first hit US shores. While unemployment is now low at 3.6%, the employment-to-population ratio is closing in on prepandemic levels. It’s worth noting that the CCI does include a section on the impact of inflation. Its sub-index of consumer expectations has been trending down since last year because of concerns about future inflation, contrary to the sub-index of confidence in the current situation, which remained elevated during this period (figure 3).

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Rising inflation poses risks for real consumer spending

High inflation and improving labor market conditions are opposing forces influencing real consumer spending. While strong job creation and declining unemployment have aided income growth, and hence spending, rising inflation can dent consumers’ momentum through three key effects.

First, inflation has affected growth in real income, thereby curtailing consumers’ purchasing power. While nominal earnings continue to rise due to labor market tightening, real earnings have been on a broad downward trend since last year (figure 4). Since January 2021, as inflation has gone up, real average weekly earnings have fallen 4.5%, even while nominal earnings rose 4.8% in this period. No wonder then, that, consumers appear worried about their finances despite strong job growth. Deloitte’s survey of consumers reveals that as COVID-19 infection cases recede, concerns about personal finances are rising.2 In March, 54% of respondents expressed concern about the amount of money they were saving; this share has been rising since June 2021 (figure 5). It’s not just income that inflation dents but also gains in real wealth, which, in turn, has the potential to weaken the positive “wealth effect” on consumer spending. Real net worth3 of households in the United States grew 9.5% last year, slower than the 14.6% gain in nominal net worth. This differential will continue to widen if inflation remains high.

(Video) Germany scrambles to avoid recession amid inflation and energy crisis | DW News

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Second, as inflation percolates down to specific spending categories, consumers will increasingly substitute some items for cheaper ones, while reining in spending on discretionary items. Since essential items such as groceries are more difficult to substitute and with the prices of even cheaper substitutes going up, consumers—especially low-income ones—will need to cut other types of purchases. According to Deloitte’s survey of consumers, three in four Americans in March cited higher prices for groceries compared to the month before; the figure has gone up over the past six months (figure 6). Rising nominal value of purchases will weigh on personal savings and stretch credit card debt. The personal saving rate (6.3% in March) is now below prepandemic levels and worries about credit card debt, as figure 5 shows, have been rising steadily since the middle of last year.

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Third, if high inflation persists, monetary tightening may turn out to be more than expected. This will impact credit growth and cost of borrowing. Those with high levels of credit card debt already paying high interest rates have much to worry as those rates are generally tied to the prime rate, which moves with the federal funds rate. Mortgage rates have also been rising since the beginning of 2021, with the 30-year mortgage rate reaching 4.95% by April 1.4 That is much higher than rates in February 2020 (monthly average of 3.66%), just before the pandemic started. Rising mortgage rates also come at a time of sharp rise in home prices. According to the Federal Housing Finance Agency house price index, home prices grew 18.2% year over year in January; price growth has been in double digits since October 2020.5 The twin effects of rising home prices and higher mortgage rates may turn off potential buyers and soften the housing market, which will then weigh on the value of housing in household balance sheets. More than others, households at the lower half of the wealth ladder are likely to be impacted by any housing slowdown as real estate has a larger share in their total assets. Real estate accounted for 53.4% of total assets held by households in the bottom half of wealth distribution, much higher than the shares for the 11–50 percentile cohort (34.6%) and the 2–10 percentile one (20.5%).6

(Video) Examining Income Inequality In The U.S. Amid Rising Prices Due To Inflation

With inflation high, consumers also face widening inequality

While rising inflation poses risks to real consumer spending and hence, economic growth, its potential impact on income inequality is also worrying.

  • Low-income households spend more on necessities such as groceries, energy, and housing than higher-income ones. Estimates quoted by Fed officials suggest that lower-income households spend about 77% of their budgets on necessities, compared to just 31% for higher-income households.7 Poorer families are therefore likely to feel the pinch of surging food and energy prices more, especially with food inflation at 8.8%—the highest since the stagflation years—and energy inflation at 32% in March.
  • Low-income households will likely find it harder to substitute products whose prices are rising than others. These households may already be purchasing low-cost versions of a product given their limited budgets and hence, there may not be a cheaper variant available to buy during times of prices rises—either they end up paying more for the product or must forego it altogether.8
  • Studies also reveal that low-income households, on average, depend more on wages and government transfers for their income, compared to households with higher incomes who also benefit from their investment earnings.9 While inflation dents real wages, as is evident from figure 4, investment income generally tends to be less affected.10 For low-income households, high inflation also comes at a time when pandemic-related transfers have been gradually phased out.

A surge in optimism may have to wait a bit

For consumers, inflation often leads to a wait-and-watch game as they adjust to rising prices and wait out the near-term impact of counter-inflationary policy on the economy. This year, that wait may turn out to be a tad longer. Oil prices, already rising in 2021, got a new boost due to the conflict in Ukraine. Producers struggling with rising input costs will now find it even more difficult not to pass on a part of that cost to consumers. And added to that, there may be more disruptions in global supply chains owing to COVID-19–related lockdowns and mobility restrictions such as the recent ones in Shenzhen and Shanghai in China.11

Unfortunately, it takes time for hostilities to end and businesses to clear backlogs. Until such time, US consumers will continue to feel the pinch of inflation.

FAQs

What happens to inflation during a recovery? ›

Inflation decreases during recessions and increases during expansions (recoveries).

How do consumers respond to inflation? ›

In short: As average selling prices rise, consumers are purchasing less or walking away with less items for the same amount of spend.

How do people survive high inflation? ›

Basic strategies to survive inflation involve spending or saving less or earning more. If you're retired, surviving inflation means using more of your savings — assuming that's something that won't leave you destitute when you're older — or finding an acceptable side hustle.

How does inflation affect consumer spending? ›

With some products you postpone purchasing it. For others, you buy in smaller quantities. For still others, you buy in larger quantities because you think bulk buying is cheaper. So ironically, inflation can actually increase the quantity your purchase, in the short run, because you're going to Costco or Walmart.

Who does inflation hurt the most? ›

In 8 out of 17 countries, lower-income groups whose consumption basket is mainly composed of essential goods are most affected by the increase in prices. Poorest households suffered a rise in prices 2 to 5 percentage points higher than the wealthiest households.

Who benefits from inflation? ›

2. Equity and Commodity Investors. Despite low economic growth rates, investors can benefit from inflation if they hold the correct stocks and commodities in their portfolios. Equity investors: Putting your money in stocks is much better than holding cash during times of high inflation.

Do consumers drive inflation? ›

And that should be a worry to the Fed because the price gains have become increasingly demand-driven, and therefore likely to be more persistent.” Demand-driven inflation is one way to say that consumers, who account for nearly 70% of economic growth, keep spending, even if they resent having to pay more.

What people buy in inflation? ›

Paying the price
  • Holidays. 35%
  • Cleaning products. 33%
  • Home improvements. 32%
  • Buying a car. 27%
  • Entertainment and subscriptions. 27%
  • 22%
  • School supplies. 22%
10 Jun 2022

How does high inflation affect customers? ›

Inflation measures how much prices for goods and services rise over time. When inflation is high, it means consumers can't buy as much with their money.

How do you beat inflation UK? ›

Here we look at some of the options for protecting your nest-egg money and pension from inflation.
  1. Stick it all in gold.
  2. Shove it under the mattress.
  3. Put it all in a high-interest savings account.
  4. Buy the shares everyone else has sold.
  5. Find a boring investment trust.
  6. Batten down your pension.
  7. Go with the clever money.
6 Aug 2022

Where do you put cash during inflation? ›

Real estate traditionally does well during periods of higher inflation, as the value of a property can increase. This means your landlord can charge you more for rent, which in turn increases their income so it is on pace with the rising inflation.

How do people survive high inflation UK? ›

Three things you must do today to beat inflation
  1. Change your investment strategy. Inflation, in moderation, is not necessarily bad for stocks, as some companies can pass costs onto consumers to balance out rising input costs. ...
  2. Protect your retirement income. ...
  3. Avoid locking your cash savings away.
20 Oct 2022

What are three effects of inflation? ›

Inflation raises prices, lowering your purchasing power. Inflation also lowers the values of pensions, savings, and Treasury notes. Assets such as real estate and collectibles usually keep up with inflation. Variable interest rates on loans increase during inflation.

Does inflation make people buy less? ›

Inflation erodes the purchasing power of your dollars over time. As the price of goods goes up, a single dollar purchases less and less. When inflation occurs suddenly, consumer spending habits may change as people eat out less, buy in bulk and switch brands. Inflation is driven by supply and demand.

Do rich people benefit from inflation? ›

This happens because inflation hurts the lower incomes but actually enriches the higher incomes. Imagine a family making $30,000 with no assets seeing a 5 percent annual inflation rate. They see their expense rise by 5 percent (losing $1,800 in buying power due to the inflation) and have no way of making it up.

What's causing inflation 2022? ›

BLS data showed that inflation eased on July to 8.5% from the 40 year peak reached on June at 9.1%. Annual inflation increased to 8.3% in August 2022, in part due to rising grocery prices. In September the Fed increased the interest for a fifth time in the year reaching a 14 year high.

How do you make money from inflation? ›

How to Profit From Inflation
  1. Commodities like gold, oil, and even soybeans should increase in price along with the finished products that are made with them.
  2. Inflation-indexed bonds and Treasury Inflation-Protected Securities (TIPS), tend to increase their returns with inflationary pressures.

Why is UK inflation so high? ›

Consumer prices, as measured by the Consumer Prices Index (CPI), were 10.1% higher in September 2022 than a year before. Increases in the costs of consumer goods, underpinned by strong demand from consumers and supply chain bottlenecks, have been one factor causing rising inflation.

Why is UK inflation higher than Europe? ›

Education and communication price inflation also contribute, reflecting rises in UK tuition fees and higher telephone service price increases. Higher utility price rises reflect an element of catch up. Eurostat estimates that energy price levels remain lower in the UK than the euro area average.

Why are retired people hurt by inflation? ›

In addition, inflation hurts those who are living off their savings and have limited market exposure that could otherwise provide higher yields. Retirees are much more likely to be dependent on their savings than a working person, who may receive cost of living increases to their salary or consistent raises.

› 2021/06/16 › what-the-heck-is-g... ›

Consumers can expect sticker shock on a variety of goods and services over the next few months, experts say.
In this article, we'll explore all about inflation - its causes, consequences, parameters to measure it, and some steps to counter surging prices. We'll...
Jerome Powell, chair of the Federal Reserve, said in June that price stability is “the bedrock of the economy.” The central bank is raising borrowing costs aggr...

How do economies recover from inflation? ›

If inflation becomes too high, the economy can suffer; conversely, if inflation is controlled and at reasonable levels, the economy may prosper. With controlled, lower inflation, employment increases. Consumers have more money to buy goods and services, and the economy benefits and grows.

How does inflation affect unemployment? ›

Inflation has historically had an inverse relationship with unemployment. This means that when inflation rises, unemployment drops. Higher unemployment, on the other hand, equates to lower inflation.

Who are the gainers during inflation? ›

Entrepreneurs are the gainers in an inflationary economy because prices of their inventories go up, thereby increasing their profits.

How can inflation be stopped? ›

Contractionary monetary policy is now a more popular method of controlling inflation. The goal of a contractionary policy is to reduce the money supply within an economy by increasing interest rates. 5 This helps slow economic growth by making credit more expensive, which reduces consumer and business spending.

What's causing inflation 2022? ›

BLS data showed that inflation eased on July to 8.5% from the 40 year peak reached on June at 9.1%. Annual inflation increased to 8.3% in August 2022, in part due to rising grocery prices. In September the Fed increased the interest for a fifth time in the year reaching a 14 year high.

What are three effects of inflation? ›

Inflation raises prices, lowering your purchasing power. Inflation also lowers the values of pensions, savings, and Treasury notes. Assets such as real estate and collectibles usually keep up with inflation. Variable interest rates on loans increase during inflation.

Why are retired people hurt by inflation? ›

In addition, inflation hurts those who are living off their savings and have limited market exposure that could otherwise provide higher yields. Retirees are much more likely to be dependent on their savings than a working person, who may receive cost of living increases to their salary or consistent raises.

Does inflation cause poverty? ›

A World Bank survey of 38 countries found that high inflation tends to lower the real minimum wage, while also increasing poverty3. If minimum wages increase less than the price of goods consumed by wage earners, a workers' real income will decline.

Is inflation worse than unemployment? ›

The answer is actually pretty straightforward: Higher unemployment is worse than higher inflation if you go by the feelings of real people rather than the theories of economists.

Why is UK inflation so high? ›

Consumer prices, as measured by the Consumer Prices Index (CPI), were 10.1% higher in September 2022 than a year before. Increases in the costs of consumer goods, underpinned by strong demand from consumers and supply chain bottlenecks, have been one factor causing rising inflation.

Who is hurt the least by inflation? ›

Inflation is at a 40-year high, but it's impacting everyone differently. Inflation hurts poor people and those on fixed incomes the most. Inflation helps borrowers and investors in stocks, real estate, and commodities.

Why is UK inflation higher than Europe? ›

Education and communication price inflation also contribute, reflecting rises in UK tuition fees and higher telephone service price increases. Higher utility price rises reflect an element of catch up. Eurostat estimates that energy price levels remain lower in the UK than the euro area average.

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