The Effect of Consumer Spending on Inflation

·3 min read
JohnnyGreig / Getty Images
JohnnyGreig / Getty Images

Consumer spending, also known as personal consumption expenditures, is the value of all goods and services bought by a country’s citizens. Personal consumption is a critical aspect of the U.S. gross domestic product. For the first quarter of 2021, consumer spending amounted to 68.3% of the entire U.S. GDP. Consumer spending is important because it keeps businesses afloat, which allows them to hire workers. However, when consumers go on a spending binge and create more demand for products than there is supply, inflation can result. Here’s a look at the factors that affect consumer spending and how they’re related to inflation.

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Factors That Affect Consumer Spending

The American consumer culture is one of the strongest in the world. However, without going into debt, consumers can’t spend what they don’t have. During the depths of the coronavirus pandemic, consumer spending shrank by a whopping $500 billion, which is an astonishing figure as personal consumption typically rises on an annual basis. Not surprisingly, this shrinkage in spending occurred at the same time as the highest unemployment spike since records began in 1948. The bottom line is that unemployment rates and personal income rates are big factors that affect consumer spending.

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How Consumer Spending Is Affecting Inflation

Inflation is the rise in the cost of goods and services. While there are numerous factors that go into the inflation rate, consumer spending is a critical component. When consumer spending rises, it can create higher inflation if demand outstrips supply.

In May 2021, the consumer price index posted a gain of 5.0% over the prior 12 months. This represented the largest spike in inflation since August 2008. Contributing factors to the rising inflation rate include record-low interest rates set by the Federal Reserve Board, numerous rounds of government stimulus money flowing to both consumers and businesses, and pent-up spending demand from consumers as businesses have reopened and stay-at-home orders have been lifted.

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The rise in consumer spending has accelerated inflation at a rapid rate because it has occurred at the same time as a global disruption in the supply chain. As various countries are at different stages of managing the coronavirus pandemic, parts and workers in various areas of the world are in short supply. Coupled with increased demand from U.S. consumers, there are now shortages of numerous products, from semiconductor chips to appliances. If demand continues at present levels or even increases, lasting component shortages will only trigger additional inflation.

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Future Outlook on Inflation

As the economy recovers from the coronavirus pandemic, some level of inflation is to be expected. However, runaway inflation can put the cost of everyday goods and services out of the reach of average Americans. Rising inflation can also trigger higher interest rates, which increases the cost of everything from home mortgages to credit cards and auto loans. Although the economy can never be predicted with certainty, no less than Federal Reserve Chairman Jerome Powell has stated that the current high inflation rate is transitory and will wane over time. According to Powell, the bulk of inflationary pressures has come from areas with pent-up demand, such as airplane tickets, hotel rooms and used cars. If this is the case, then inflation should indeed moderate as the bounceback in demand normalizes and supply chain shortages get resolved.

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Last updated: July 12, 2021

This article originally appeared on GOBankingRates.com: The Effect of Consumer Spending on Inflation

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