U.S. Consumers are Poised to Cut Back Spending. What Will It Mean for the Economy?

Consumers play a major part in the economy — they provide about 68% of GDP — and they’ve had an important role in how the Federal Reserve has looked at inflation and interest rates.

The higher wages have gone, and the more consumers have spent, the greater the concern the Fed has had, seeing these as factors helping to push and reinforce inflation.

And, up until now, consumers have seemed energetic, confident, and ready to keep spending, even as prices have risen. That may be coming to an end.

Multiple indicators are showing concern on the parts of consumers:

• In the July Survey of Consumer Expectations from the Federal Reserve Bank of New York, which came out in August, when it came to expected to household, the median prediction said that it would grow 3.2% in a year, which would see households losing buying power with incomes that didn’t keep pace with the 3.5% one-year rate of inflation they expected. Also, 46.7% of those surveyed thought that inflation would be above 4%.
• The Conference Board Consumer Confidence Index declined in August to 106.1 from July’s downwardly revised 114.0. The Expectations Index of short-term consumer outlooks for income, business, and labor market conditions dropped from July’s 88.0, which was a sharp jump up, to 80.2. “Consumer confidence fell in August 2023, erasing back-to-back increases in June and July,” Dana Peterson, chief economist at The Conference Board, said in prepared remarks. “August’s disappointing headline number reflected dips in both the current conditions and expectations indexes. Write-in responses showed that consumers were once again preoccupied with rising prices in general, and for groceries and gasoline in particular. The pullback in consumer confidence was evident across all age groups—and most notable among consumers with household incomes of $100,000 or more, as well as those earning less than $50,000. Confidence held relatively steady for consumers with incomes between $50,000 and $99,999.”
• Many economists expect that consumer price data due Wednesday will show prices 3.6% higher in August than a year earlier.
• “After staving off recession for longer than many thought possible, the US consumer is finally about to crack,” according to Bloomberg’s Markets Live Pulse survey. More than half of the 526 people who responded thought that their personal consumption would drop in 2024, the first quarterly decline since the start of the pandemic. “Another 21% said the reversal will happen even sooner, in the last quarter of this year, as high borrowing costs eat into household budgets while Covid-era savings run down.”

Consumer credit card indebtedness reached an all-time high of more than $1 trillion by August 30, 2023, according to Federal Reserve data. With more debt and higher interest rates, debt service increases, leaving less money for other purchases. Even with inflation slowing significantly, most prices remain higher than inflation-adjusted household incomes.

How the Fed might react is, as always, more complex than a response to a single factor. Less spending means less demand. That and gradual improvements should mean less upward, and maybe some downward, movement on prices as companies look to bring customers back to retail counters. That would seem additional evidence that rate hikes should remain paused, if not lowered in the near future.

But this isn’t a time to claim victory. As consumer spending drops, so does the main force to bolster GDP. That could mean the country finds itself in a recession, with visions of a soft economic landing sailing off in the distance.