Affluent Americans Driving the US Economy and Delaying Fed Rate Cuts
In recent years, the US economy has experienced a sustained boost, largely driven by affluent Americans. This group, benefiting from significant gains in the stock and housing markets, is now accounting for a larger share of consumer spending than ever before. Their spending, particularly on higher-priced services such as travel, healthcare, and entertainment, is putting upward pressure on prices and inflation. Interestingly, this spending is relatively immune to the Federal Reserve’s efforts to slow down the economy through higher borrowing rates, as it rarely requires borrowing.
One example of this trend is Joan Harris, a 64-year-old engineer from Albuquerque, New Mexico. Since retiring two years ago, Harris has increased her travel activities, visiting her adult children in different states and planning multiple other trips, including a science fiction convention in Scotland and a Disney cruise. She admitted that she now has more money to spend than when she was working, and she’s willing to splurge on first-class plane tickets and higher-level suites. Harris’s newfound perspective is driven by the realization that life is short, and she wants to enjoy these experiences while she can.
Older Americans like Harris are contributing significantly to the US economy. Their increased spending power, fueled by the wealth accumulated from the stock and housing markets, has become a primary driver of economic growth. This surge in spending, particularly in higher-priced services, is also contributing to inflationary pressures. However, this type of spending is not affected by the Federal Reserve’s attempts to control inflation through higher borrowing rates, as it is primarily funded by accumulated wealth rather than borrowing.
The Wealth Effect and the Fed’s Dilemma
The “wealth effect” is a significant factor in the US economy’s unexpected strength. Rising home and stock values give people confidence to increase their spending, thus driving economic growth. This unexpected strength has forced the Federal Reserve to reconsider its plans for rate cuts. Initially, policymakers projected three rate cuts for this year, but the sustained strength of the economy, fueled by affluent spending, has led to a shift in the Fed’s plans.
Chair Jerome Powell recently made it clear that the Fed is not confident that inflation is sustainably easing, which has deterred them from cutting rates. Inflation measures have remained uncomfortably high, partly due to brisk consumer spending. As a result, the Fed is expected to keep its benchmark rate unchanged at a 23-year high during their upcoming meeting.
The Federal Reserve’s rate hikes have had a significant impact on borrowing costs across the economy. Home and auto loans, credit cards, and business loans have all become more expensive. However, despite these higher borrowing costs, stock and home values have continued to rise, resulting in an increase in the net worth of affluent households. Since 2018, household wealth has grown at an accelerated rate of nearly 9% per year, compared to an average of 5.5% in the decade following the 2008-2009 recession.
The Impact on the Economy and the Fed’s Response
The sustained spending by affluent Americans has had a significant impact on the US economy. Consumer spending, driven by this group, has become the principal driver of economic growth. However, this spending has also contributed to stickier inflation, making the Fed cautious about implementing rate cuts.
Furthermore, affluent older Americans who own government bonds may even benefit from the Fed’s rate hikes. Higher bond yields resulting from rate hikes generate more income for bondholders. This additional income further contributes to the spending power of affluent households.
The Federal Reserve’s dilemma lies in balancing the need to control inflation with the desire to support economic growth. The unexpected strength of the economy, fueled by affluent spending, has forced the Fed to reconsider its plans for rate cuts. While the Fed’s rate hikes have increased borrowing costs, the wealth effect has continued to drive consumer spending and economic growth.
In conclusion, affluent Americans, particularly older individuals, are playing a significant role in driving the US economy. Their increased spending power, fueled by gains in the stock and housing markets, has become the primary driver of economic growth. This spending, particularly on higher-priced services, is relatively immune to the Federal Reserve’s efforts to control inflation through higher borrowing rates. As a result, the Fed is facing a dilemma in determining the appropriate course of action to balance inflation control with economic growth support.
