Inflation: Same Storm, Different Boats

Whose Inflation Is It Anyway?

The highest inflation in nearly 40 years, as measured with the Consumer Price Index (CPI) rising 7.0% through December (Figure 1), has been an unpleasant pill to swallow for all Americans. But while the pain has been widespread, it has not been evenly felt. The CPI calculates the average change in prices across the average consumption basket. It accounts for the fact that in any given month prices for some items rise while others fall. The variation across categories is on full display in tables detailing price changes for everything from tires to baby food to veterinarian care. Less apparent, however, is how the cost of living is changing for different consumer groups.

The reality is that consumers' purchase patterns vary widely. Not everyone owns a car, needs to feed an infant, or cares for a pet. Different mixes of goods and services consumption can lead to distinct inflation experiences. The past year has seen the sharpest price rises in at least a decade, if not ever, for purchases like vehicles, food, household goods, medical equipment, hotels and housing. Gasoline prices are up 50%, while energy utilities are up 10%. Who does this inflation hurt the most?

Consumers' purchase patterns, and thus cost of living changes, can vary widely.

Pain Points: Variation in Inflation Experiences

To determine who is facing the fiercest onslaught of inflation at present, we constructed inflation indices unique to different consumer groups. To do this, we utilized the detailed spending data from the U.S. Department of Labor's Annual Consumer Expenditure Survey (CES), on which the CPI basket is based. In short, we pulled spending and inflation for 24 categories to account for the variation in buying patterns and pricing developments over the past year.¹ We then developed inflation indices across income cohorts, race/ethnicities and age groups by utilizing the 2019-2020 weights from the CES. CPI data through December are weighted by 2017-2018 spending, but we utilize the 2019-2020 period to better reflect buying patterns over the past year, as while not in a full-fledged stay-at-home economy anymore, spending is not back to pre-pandemic patterns either.² Using our weights and more condensed category groupings leads to a less volatile measure of CPI, which still closely tracks the ups and downs of the published headline (Figure 2). Our calculation shows CPI for all consumers up 6.5% over the past 12 months, which is still leaps and bounds higher than the pre-COVID experience of roughly 2% inflation from 2014 to 2019.

We provide a brief discussion of how inflation rates vary across income cohorts, races and age groups in the remainder of this section. For a full look at the contributions from different spending categories to the headline inflation indices, please see the Appendix of this report.

Income: It's a Squeeze in the Middle

Looking at inflation by income shows middle-income consumers have faced the steepest rise in living costs this past year. Inflation for this group has risen 6.7%, half a point stronger than households at both the top and bottom ends of the income spectrum (Figure 3). The bell-shaped curve in inflation can be traced to higher transportation costs. Gasoline and used vehicles, the juggernauts of this past year's inflation, account for a larger share of middle-income budgets than other groups. Top earners direct more of their spending to new vehicles, where prices have risen less than used cars, and direct the smallest share of spending toward gasoline of any group. Meanwhile, inflation for the bottom income quintile has been relatively lower since this group devotes the smallest share of spending to any sort of vehicle purchase and gasoline.

Middle-income consumers have faced the steepest rise in living costs this past year.

Instead, spending for the bottom-income quintile is skewed more toward basics like groceries, rent and utilities. With the exception of natural gas, which accounts for only a sliver (1.0%) of spending for this group, the CPI sub-indices for these items have not risen to quite the extremes as the overall CPI (Figure 4). Similarly, areas where higher-income household spending is more heavily directed (like education, recreation and food away from home), have not seen prices rise as steeply as headline inflation. Lodging away from home, (i.e. hotels), included in "hotel/motel" in Figure 4, is the lone area of top exposure to above-average price gains.

Race/Ethnicity: Varied Inflation on Full Display

Even more distinct inflation experiences emerge when looking at inflation across major racial and ethnic groups.³ Hispanic and Latinos have faced sharply higher inflation than other groups this past year, while Asian Americans have seen a more moderate rise in prices (Figure 5). The patterns of inflation by race and ethnicity bear similarities to those by income. Asians earn significantly more than the average American household and direct a relatively higher share of purchases toward categories that have seen more restrained price rises relative to the average, like education, food away from home and housing. Hispanic and Latino income is similar to that of middle-quintile consumers, but an even greater share of spending is directed toward vehicle purchases (particularly used autos) and gasoline prices, leading to the highest rate of inflation of any sub-groups we analyze.

Age: Once Again, Boomers Come Out Ahead

With spending patterns varying across the consumer life cycle, the surge in inflation this year has also been felt unequally across age groups. Older Millennials, who are roughly 35-44, have experienced the steepest rise in prices over the past year, while younger Millennials (25-34) and Gen Z have not fared much better (Figure 6). These younger consumers devote a greater share of spending toward vehicles and gas. Gen Z has at least gotten a small reprieve from education prices rising a comparatively tame 2.0% this past year. But healthcare has also driven a major wedge in the inflation experiences between young and old. Healthcare accounts for 16% of spending for consumers ages 65+ compared to just 4% of those under 25, with prices growing at a rather run-of-the-mill rate for both services and goods this past year (2.5% and 0.4%, respectively).

The Significance of Small Differences

While the variation in inflation rates may not appear all that striking, they do not fully capture the disproportionate effect of sharply rising costs on different consumer groups. Lower-income consumers, which are more likely to be Hispanic or Latino, Black and/or young, are more constrained in their ability to adjust to higher prices. These households have less accumulated savings to draw on, or more limited room to reduce current saving rates, to smooth consumption.

In addition, with a greater share of spending devoted to basics like housing, groceries and utilities, lower-income households have less scope to adjust to broadly rising prices by forgoing more discretionary purchases or trading down in price. For example, high-income households may be able to delay ordering a new car or chose a vehicle with fewer features. Lower-income households may need to turn to older, less reliable cars, or forego purchasing a vehicle entirely due to higher prices. Higher-income consumers also have the luxury to skip or scale down vacations, avoiding the 24% increase in hotel costs and 36% rise in rental car prices this past year. Given the more constrained choice set of lower-income households, perhaps it is not surprising that according to a recent NORC Poll, half of households earning less than $50,000 a year say price increases have had a major impact on their finances, while only one-third of those in households earning more than $50,000 a year say the same.⁴

At the same time, our indices are likely to understate the experienced inflation of lower-income households relative to measured inflation from the CPI this past year. Rent is the largest category for spending across the two lowest income quintiles, while owned housing is the largest category for the three highest. Although the CPI for owner's equivalent rent has risen 3.8% over the past 12 months, the vast majority of mortgage payments are fixed, meaning owners' actual costs have not changed. What's more, homeowners have been able to build equity in this environment of fast-rising home prices. Renters, on the other hand, face more frequent adjustments, with prices typically changing with each new lease. The methods in which the CPI measures rented and owned shelter also tend to both delay and understate how changes in market prices feed through to official inflation measures.⁵ Market-based measures show rent increasing substantially faster this past year than indicated by the CPI (Figure 7).

Lower-income households have less scope to adjust to broadly rising prices.

Silver Lining: Lower Income and Younger Coming Out Ahead on Wages

Although lower-income consumers have less room to maneuver when dealing with the current onslaught of inflation, there has been some relief in the form of rising wages. Not all low-income households include someone who is working, but for those that do, they are likely to be benefiting from stronger wage growth in lower-paying jobs. For example, average hourly earnings (AHE) in the leisure & hospitality industry have grown 13.5% this past year. Our own groupings of earnings by 75 industries show explosive AHE growth in the two lowest-earning quintiles, which has exceeded the headline rate of inflation (Figure 8).

Similarly, young workers' wages appear to have done a better job keeping pace with inflation this past year. As of December, the Federal Reserve Bank of Atlanta's Wage Tracker shows a median hourly wage increase of 10.5% over the past year (on a 12-month average basis), compared to 4.0% for prime-age workers and 2.3% for workers over the age of 55. With an already-low unemployment rate, elevated job openings and employers desperate to limit turnover, these workers may continue to see real gains in income despite the high pace of inflation.

Lower-income consumers have seen some relief to inflation in the form of rising wages.

Spending Steered by Select Few

So what do these varied inflation rates mean for overall household consumption? With higher prices eating into the purchasing power of consumers, the natural consequence would be a decline in real consumption as more dollars are required to purchase the same amount of goods and services. This is likely true for specific groups today, like low- and middle-income households who, as mentioned previously, spend a larger share of their overall income and have less wiggle room when it comes to financial choices. But on a macro scale, the impact should be fairly minimal. That is due to household consumption in the United States being heavily concentrated in higher-income cohorts. The top 20% of households account for nearly 60% of total personal outlays.⁶ In other words, a sharper pullback in real spending among low- and middle-income consumers due to high inflation would contribute to a slowdown in aggregate spending, but it is unlikely to meaningfully constrain total consumption growth going forward.

Furthermore, many households are in relatively better financial shape today than they were prior to the pandemic, which should help them to weather this inflationary storm. Household net worth has risen across income cohorts amid the run up in asset values over the past year (Figure 9). While the gain in equity values tends to benefit higher-income households more, the gain in home values has contributed to the rise in net worth of lower- and middle-income groups (equities represent just under half (47%) of the assets held by the highest-income cohort, whereas real estate is nearly half (48%) of the lowest). In addition to the rise in asset values, another potential factor mitigating the hit to consumption is the fact that the fiscal support infused into the household sector over the past year granted lower-income households some ability to build savings. The bottom 20% of households saw the highest personal saving rate of any income cohort over the past year (Figure 10). While this dynamic is set to fade going forward with the absence of stimulus and higher prices, the ability to save or pay down debt over the past two years leaves many households in a better financial position today.

Most households are in relatively better financial shape today than they were prior to the pandemic.

"Broad-Based and Inclusive" Is Not Just for the Labor Market

Prior to the COVID downturn, the Fed had grown more attuned to the disproportionate effects monetary policy has across the socioeconomic spectrum. Specifically, the idea that a strong labor market yielded particular benefits for more marginalized communities gained traction; eventually it became incorporated into the 2020 update of the Fed's Longer-Run Goals and Monetary Policy Strategy under the notion that “maximum employment is a broad-based and inclusive goal.” Greater emphasis on creating a strong labor market, even when by most measures the jobs market of the late 2010s was already tight, was a reasonable goal in an environment where inflation was struggling to hit 2% on a sustained basis.

The disproportionate impact of high inflation on lower-income consumers also suggests a more nuanced view of the FOMC's policy stance—in this case with the scales tilted toward tighter policy. The FOMC already appears to be heeding this approach. At the December FOMC meeting, the Committee outlined the potential for increasing the fed funds rate 75 bps this year, but in Powell's press conference following last week's meeting, he hinted that policy tightening would not only come as soon as this March, but could very well be followed by more this year than previously outlined as the inflation situation “hasn't gotten better, it's probably gotten just a bit worse.” If the FOMC's “broad-based and inclusive” mentality extends beyond the labor market to overall economic well-being, which we suspect it does, then the uneven toll inflation is taking on mid- and lower-income households should give it greater resolve in bringing down inflation quickly before it has the further chance of becoming entrenched.

The disproportionate impact of high inflation on lower-income consumers tilts the scales toward tighter monetary policy.

Appendix

Source: U.S. Department of Commerce and Wells Fargo Economics

Endnotes

¹ We pulled spending categories from the CES and matched them to pricing categories from the CPI. Our analysis covers 24 categories of spending, which equates to about 83% of total spending as measured by the CES. Our analysis purposely does not include some areas of spending like cash contributions and personal insurance & pensions, since these outlays are not captured in the CPI basket. We thus reweigh the consumption baskets across the various groups based on the 24 categories of consumption in our analysis. (Return)

² The 2019-2020 weights will also be more consistent with the CPI updating weights to the same year with the release of its January 2022 data next week. (Return)

³ Note, race and ethnicity are not mutually exclusive. Individuals whose ethnicity is identified as Hispanic or Latino may be of any race. (Return)

⁴ Rugaber, Christopher and Hannah Fingerhut. “Americans are focused on inflation as income go up, AP-NORC poll finds”. Associated Press. December 2021. (Return)

⁵ See “Gimme Shelter or Inflation Gonna Fade Away” (Oct. 8, 2019) for more details on how shelter costs are calculated for the CPI. (Return)

⁶ Estimates on personal outlays shares by income are estimated by Moody's Analytics based on data from the Federal Reserve Board, Bureau of Economic Analysis and U.S. Department of Census. These estimates cover personal outlays, which in addition to personal consumption expenditures includes nonmortgage interest payments and net transfers to government and persons outside of the United States. (Return)