How Did Consumers Weaken The Economy In The Late 1920s – Akrur Barua is an economist in the Research & Insights team. A regular contributor to several Deloitte Insights publications, he writes frequently on emerging economies and macroeconomic trends with global implications, such as monetary policy, real estate cycles, household leverage and trade. It also examines the US economy, particularly demographics, the labor market, and consumers.
Consumers are at the forefront of the post-pandemic recovery, with real consumer spending expected to grow 12.1% in 2021.
How Did Consumers Weaken The Economy In The Late 1920s
Sustaining this recovery in the medium term therefore depends on their ability and willingness to increase their purchases. So it’s alarming to see different sentiment across two key indicators of consumer sentiment. As shown in Figure 1, the University of Michigan’s Index of Consumer Sentiment (ICS) has trended significantly lower than the Conference Board’s Consumer Confidence Index (CCI) since early 2021. This is unprecedented, as two measures have never given such different signals. Does this mean we really don’t know the roots of American consumers? Fortunately, that’s not the case. The difference between these two indicators is largely due to inflation and its greater role in the CEC than in the CPI. This leads to a more important question: does high inflation threaten real consumer spending growth? The answer is yes. Rising inflation puts a strain on consumer purchasing power and slows or even reverses growth in real wages and wealth. This often forces households – especially those with low and middle incomes – to forego discretionary spending. Worse, higher-than-expected inflation could force a strong dose of monetary tightening, further weakening consumer spending impulses. Inflation also hurts low-income households more than others, exacerbating income inequality.
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The ICS fell to 59.4 in March – the lowest reading in 10 years – as inflation dominated people’s worries about personal finances and economic growth. In the survey, one-year inflation expectations rose steadily to 5.4% in March from a year earlier. This is not surprising given that inflation rose to 8.6% in March, the highest level since the early 1980s. Core personal consumption expenditure (PCE) inflation, closely monitored by the United States Federal Reserve (Fed), was 5.4% in February, above the Fed’s April 2021 target of 2% (Figure 2).
Inflation concerns – as evident in the ICS data – are less reflected in the CCI, which focuses more on the labor market. This is the main reason behind the higher tuition for CCI compared to ICS. The labor market has been steadily improving since the pandemic first hit US shores in the first half of 2020. Although unemployment is now as low as 3.6%, the employment-to-population ratio is approaching pre-pandemic levels. It should be noted that the SEP includes a section on the impact of inflation. Its consumer expectations sub-index has been declining since last year due to concerns about future inflation, in contrast to its current confidence sub-index, which has remained high over the period (Figure 3).
High inflation and an improving labor market are opposing forces affecting real consumer spending. Although stronger job creation and lower unemployment support income growth, and thus spending, rising inflation can dampen consumer sentiment through three main effects.
First, inflation affects real income growth, thereby reducing consumer purchasing power. Nominal incomes continue to rise due to a tightening labor market, while real incomes have had a broad downward trend since last year (Figure 4). Since January 2021, real average weekly earnings have fallen by 4.5% due to rising inflation, but nominal earnings have risen by 4.8% over the same period. So it’s no surprise that consumers are worried about their finances despite strong job growth. Deloitte’s survey of consumers shows that as the number of people infected with COVID-19 decreases, concerns about personal finances increase.
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In March, 54% of respondents expressed concern about the amount of money they were saving; this share has been increasing since June 2021 (Figure 5). Inflation not only reduces incomes, but also increases real wealth, which in turn weakens the positive “wealth effect” on consumer spending. Real net worth
The number of households in the United States grew 9.5% last year, slower than nominal net wealth growth of 14.6%. If inflation remains high, this gap will continue to widen.
Second, as inflation erodes certain categories of spending, consumers increasingly trade some items for less expensive ones, while limiting spending on discretionary items. As essentials such as food become more difficult to substitute and even cheaper substitutes become more expensive, consumers, especially those with lower incomes, are forced to cut back on other types of purchases. According to a Deloitte survey of consumers, three out of four Americans reported higher grocery prices in March compared to the previous month; The indicator has increased over the past six months (Figure 6). An increase in the face value of purchases affects personal savings and increases credit card debt. The personal savings rate (6.3% in March) is below pre-pandemic levels, and concerns about credit card debt have been rising steadily since the middle of last year, as shown in Figure 5.
Third, if high inflation persists, monetary tightening may be greater than expected. This affects credit growth and the cost of debt. Those with high levels of credit card debt who are already paying high interest rates should be especially concerned because those rates are usually 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% as of April 1.
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This is significantly higher than the level in February 2020 before the start of the pandemic (monthly average of 3.66%). The rise in mortgage rates also comes at a time when housing prices are skyrocketing. According to the Federal Housing Finance Agency’s home price index, home prices rose 18.2% in January compared to last year; price growth has been in double digits since October 2020.
The twin effects of higher home prices and higher mortgage rates can deter potential buyers and dampen the housing market, which then affects home prices on household balance sheets. Households in the bottom half of the wealth ladder are likely to be more affected than others by any slowdown in the housing sector, as real estate accounts for a larger share of their total assets. Real estate accounted for 53.4% of total household assets in the bottom half of the wealth distribution, much higher than the shares in the 11-50 percent (34.6%) and 2-10 percent (20.5%) cohorts.
While rising inflation threatens real consumer spending and thus economic growth, its potential impact on income inequality is also worrisome.
For consumers, inflation often results in a wait-and-see game as they adjust to rising prices and wait for the short-term effects of anti-inflationary policies on the economy. This year, that wait may be a little longer. Rising oil prices in 2021 have received another boost due to the conflict in Ukraine. It will be even more difficult for producers struggling with rising raw material prices to avoid passing on some of those costs to consumers. In addition, global supply chains are likely to experience more disruption due to disruptions and mobility restrictions related to COVID-19, such as the recent ones in Shenzhen and Shanghai, China.
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Unfortunately, it will take time for the hostilities to cease and businesses to clear the backlog. Until then, US consumers will continue to feel the pinch of inflation.
The Deloitte Global Economist Network is a diverse group of economists who create relevant, engaging and thought-provoking content for external and internal audiences. Industry and economic expertise of the industry allows for complex analysis of complex industry issues. Publications range from in-depth reports and critical leadership to executive briefings designed to keep senior management and Deloitte partners informed on current issues.
Even as supply chain bottlenecks and energy pressures are resolved, will upward wage pressures keep inflation high? 1 year ago The current coronavirus outbreak has prompted politicians around the world to implement policies to counter the economic effects of the crisis. These economic effects can be severe, and policymakers must consider whether the structure of tax systems can lead to large revenue losses or prevent economic recovery once health risks have subsided.
The Great Recession provides some insight into how tax revenues have declined during deep recessions. In OECD countries, revenues fell by 11 percent from 2008 to 2009, and corporate income tax fell by a sharp 28 percent. Income from personal income tax decreased by 16 percent.
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Income from consumption taxes decreased by 9 percent, and income from social security taxes decreased by only 5 percent.
OECD countries mostly rely on revenue from consumption taxes, social security and personal taxes. But not all countries have the same tax structure, and some tax systems are better designed to handle downturns than others.
Income taxes are more variable than consumption taxes, mainly because
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